The 7 yr auction, the 1st of course since the Fed events of yesterday, was somewhat soft. The yield was above the when issued by about 1 bp and the bid to cover of 2.73 was below the 12 month average of 2.82. Direct and indirect bidders also took the least amount since May ’09. Bottom line, the Fed can pin short rates to any level they want but once you get past 5 years, inflation expectations become an influence and the marketplace adjusts those rates. Due to the Fed’s attempt to juice inflation, the implied inflation rate in the 5 yr TIPS today has risen to 2.03%, the highest since August. Implied expectations 10 yrs out are at 2.13%, just shy of the highest since Oct ’11. We don’t know if this rise in inflation expectations was a factor in the mediocre auction today but there is no question the Fed continues to play inflation chicken with the longer end of the yield curve. For now though, the Fed has certainly won (helped out by Europe’s debt problems).
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