Mortgage rates stayed at their 2005 highs, just below 6.5 percent for the lowest-fee 30-year loans, but trading in the all-important Treasury bond market suggests that long-term rates may be nearing a top.

There were no market-moving economic data last week, but the Treasury had $44 billion in new bonds to sell at auction and the behavior of the bidders tells a tale.

The Treasury borrows constantly to roll over old debt and to raise new cash, but it raises the big money in a few “refunding” weeks. Nobody gets a refund in this misnomer; the ancient term refers to the Treasury re-funding its empty coffers.

New cash comes from selling new IOUs. The Treasury wants to get the best price possible when selling, and so conducts auctions; the winning bidders get the lowest interest rate from the Treasury. Yes, in our government, somebody actually wants to get the best possible deal for the taxpayer, and Halliburton is not involved; the bidders are limited to three-dozen heavily regulated “primary dealers.”

These dealers are giant securities firms and banks who in exchange for status as insiders must bid at the Treasury’s auctions (very, very bad form for any national treasury to offer bonds for sale and not find enough takers). The primaries bid for their own accounts, and collect customer bids; these customers agree to accept whatever yield results from the competitive auction, and their bids are called “non-comp.” Included in non-comp are bids by foreign central banks, the crucial recycling of petrodollars, Chinabucks, and the rest of our trade deficit.

The non-comp bidders always get all the bonds they asked for, and the remainder is awarded to the competitive bidders beginning with the lowest rate offered, ascending until the whole issue is subscribed. This allocation leads to some dicey planning for the competitive bidders. If fewer non-comps show up than dealers think, then more of competitive bids get accepted, and the dealers wind up with a pile of un-hedged bonds that have to be dumped at a loss.

The aftermath of an auction like that is not a pretty sight, as market prices sink and yields soar.

The reverse happens after an auction surprisingly heavy with non-comps. Dealers don’t get enough bonds; they have shorted the market ahead of the auction, pre-hedging delivery, and to cover the un-filled shorts they have to buy from the market. Prices rise and yields fall.

That’s what happened Thursday: at Thursday’s auction of $13 billion of new 10-year T-notes, non-comp bidders took 54.8 percent of the bonds, an all-time high. T-note yields before the auction were 4.66 percent and trading weakly, tending to higher; after the auction, the 10-year rallied to 4.55 percent, the lowest in two weeks.

Now, some of the rally may have been no more than technical short-covering. However, some of the rally certainly came from the pleasant sign of foreign central banks still buying huge quantities of American bonds.

If the rally fades today, mortgages are still at risk to go above – well above – 6.5 percent. However, one aspect of the rally makes me think that something else is going on, a preliminary signal that no matter what the Fed does from here, long-term rates may be near a top: the spread between the 2-year T-note and the 10-year contracted to .14 percent.

During months of the Fed bulldozing rates upward from underneath, the 2s-10s spread has stayed wider than .2 percent. A spread contracting further, or crossing over to “inversion,” is the surest sign that every step upward taken by the Fed from here will increase the risk of recession, and the chance for lower rates of all kinds later in ’06.

No spread follow-through this week…the reverse, everything going higher.

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at


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