Treasury Makes History With First Two-Year Note Auction Premium

Long-term U.S. Treasury yields may be surging lately, but investors were served a reminder Tuesday of just how incredibly low short-end rates still are.

The department’s $60 billion sale of two-year notes on Tuesday broke one of the few remaining records of the low interest-rate era when it drew a yield of 0.119%. Because Treasury notes and bonds by regulation have a minimum coupon rate of 0.125%, the yield below that level means the notes were sold at a premium above 100 cents on the dollar -- 100.011965, to be precise -- something that’s never happened before.

A new-issue premium has few if any practical implications. However, it highlights what’s happening in U.S. short-term interest rates, where yields on Treasury bills have flirted with zero this month as the government removes supply even as a wall of cash looks for a home. That phenomenon, and the Federal Reserve’s pledge to keep policy ultra-loose for the foreseeable future, is widening the gulf with long-term rates. Yields on those maturities have risen to the highest in about a year on the prospect of economic recovery and faster inflation.

“When the Fed’s committed to keeping rates at or near zero, twos are probably cheap at 10 basis points,” said Glen Capelo, managing director at Mischler Financial, who began trading Treasuries in 1986. “It’s a little crazy that you have to buy them at that yield, but that’s your choice.”

Treasury notes and bonds are assigned coupons based on their auction yield. The convention is to affix the highest possible coupon that doesn’t result in a premium price. A two-year note drawing 0.125% to 0.249% at auction would be issued with a 0.125% coupon at a price of 100 or lower. One drawing a yield below 0.125% would be issued with a 0.125% coupon at a price above 100.

Treasury Makes History With First Two-Year Note Auction Premium

Treasury note and bond auctions that previously have resulted in premium prices have included reopenings and TIPS auctions. In a reopening, more of an existing security is sold, and if the auction yield is lower than the coupon, the price will be a premium. Several TIPS new issues also have sold at premiums because they’ve drawn yields below 0.125%.

For today’s traders, the highest-ever coupon rate for a Treasury security must be hard to imagine: 16.25% for the two-year sold in August 1981, according to Bloomberg data.

©2021 Bloomberg L.P.

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