With Operation Twist being extended for another 6 months, forcing Primary Dealers to buy up all the short-end bonds from the Fed, the last thing the Dealer community needed at today's 2 Year bond auction was to be stuck holding the bag. Which is precisely what happened: the Treasury sold $35 billion in fresh 2 year paper as the first auction of this week's trio of bond issuance, at a yield of 0.313%, the highest since March even if in line with the When Issued, and a Bid To Cover of 3.62, the lowest since February. But the key internal indicator was the distribution between the Primary Dealer take down and everyone else: at 60.4% of the entire offering or $21 billion, going to Dealers, this was the highest notional having to be stuffed in the channels of the Primary Dealer repo market since December 2011. Naturally, the offset, Direct and Indirect takedown, was quite low, with Indirect bidders holding just 31.69% of the auction, or the lowest since December as well. Unless the PDs can offload the bonds quickly and effectively, this means they are stuck with another product for $21 billion which will generate returns far lower than ROI and ROE breakevens, and force them to take even more risks with whatever other capital they have lying around courtesy of US depositors.
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