Treasury’s New Notes Pull in $7 Billion-Plus

The U.S. Treasury on Wednesday sold more than $7.003 billion in 10-year inflation-indexed notes at the first auction of the new securities.

Demand for the notes exceeded supply by more than 5 to 1, which was more than double the demand of a typical government notes auction. Bids totaled more than $37 billion.

Treasury Secretary Robert E. Rubin said that the notes, which sold at a yield of 3.449%, were auctioned at “a fair price to sell, a fair price to buyers.”

The notes--to be auctioned quarterly and pay semiannual interest--will rise or fall in value, with a three-month lag, tracking increases in the consumer price index calculated by the Labor Department. Inflation adjustments will be added to the notes’ principal and be payable at maturity.

The strong bidding suggests “investors are worried about inflation,” said Krishna Memani, a government bond strategist for Morgan Stanley & Co., though consumer prices have been running at some of the lowest levels since the 1960s.

“It’s astounding,” said Dung Vu, managing director of CoreStates Investment Advisors in Philadelphia, which manages $6 billion in fixed-income assets. Still, he said, he wasn’t among the bidders because “nobody can really tell how this market will operate.”

Several mutual fund companies, including Dreyfus Corp., are creating funds to invest in the new securities, saying there may be a huge market for these new fixed-income securities whose value is immune to inflation.

Pimco Advisers in Newport Beach bought about $100 million of the new securities for its new mutual find, said William Gross, who overseas $88 billion in notes and bonds at the firm.

“We bid for more and wish we got more,” Gross said.

The Treasury expects to sell similar securities with other maturities--as well as inflation-indexed savings bonds--once the program gets underway. Wednesday’s offering represents a small fraction of the government’s more than $3 trillion in tradable debt. The Treasury will continue to sell its standard 10-year notes six times a year.

Rubin said that it would take some time for small investors in particular “to come to grips with a new security” and that the Treasury Department would wait to see just what to do next. Asked whether the rates on the notes would come down, Rubin said during a television interview, “I think we have to see how this rate changes as the market seasons.”

Rubin has pitched the new securities as an ideal way to save for college tuition or retirement.

“Over time this will increase the savings rate,” Rubin said. He also said the notes could reduce the Treasury’s cost of borrowing if inflation remains low. Last year, consumer prices, outside of food and energy, showed one of the smallest gains in three decades, 2.6%.

Demand for the new notes “would certainly suggest to me that the government will, in fact, have a lower cost of money” because of the lower interest rate, compared with conventional notes, Rubin said.

Like other Treasury securities, the new notes will be exempt from state and local taxes. They will be subject to federal income taxes, and in that respect there is a difference with most other Treasury issues: Inflation adjustments to principal will be taxed when credited--even though investors won’t get that money until the notes mature.