Why stock investors will monitor Treasury auctions closely

"The one thing that makes this all plausible is that last week, the Fed Chairman [Ben Bernanke] in his testimony to Congress stated that while the recovery may be underway, it will not likely include inflation," said Kevin Giddis, head of fixed income trading and research, Morgan Keegan.

"This was the best news the markets could hope for and it is likely the reason for the rally in stocks," said Giddis of last week's trade, which on Friday had the Dow industrials closing at their highest level since early November.

On Monday, stocks and Treasury prices fell as the government kicked off what will be a record $235 billion in government bills and notes put up for sale this week. Read the Bond Report.

Financials and consumer discretionary shares fronted the late-session turn higher as the Dow Jones Industrial Average /quotes/comstock/10w!i:dji/delayed (INDU 9,108, +15.19, +0.17%) ended at 8,108.51, up 15.27 points, or 0.2%. The S&P 500 Index /quotes/comstock/21z!i1:in\x (SPX 982.18, +2.92, +0.30%) added 2.92 points, or 0.3%, to 982.18, its highest closing level since the broad-market gauge topped the 1,000 mark on Nov. 4, 2008, while the Nasdaq Composite [s: comp] rose 1.93 points, or 0.1%, to 1,967.89.

Supply issues

The auctions, which will surpass the record $104 billion sold in late June, should bring back in play the issue of "overwhelming supply," a valid concern offset so far "by the outlook for growth, or lack thereof, in the second half of the year," said Dan Greenhaus, an analyst with the market strategy group at Miller Tabak & Co.

"Should below trend growth prove a reality, the potential impact on corporate earnings, stock prices and the Treasury market cannot be discounted," said Greenhaus.

"If the stock market is right and the economy in the second half of the year will have a strong rebound, then interest rates are going higher due to higher inflation and demand on the part of foreigners, who own half our debt, and others for higher yields for the enticement of buying the enormous new supply," said Peter Bookvar, equity strategist at Miller Tabak.

Monday's auction had the Treasury selling $6 billion in inflation-indexed securities at a yield of 2.387%.

"The backdrop of this auction was implied inflation expectations that have ticked up over the past few weeks to the highest level since mid June, with the rally in stocks and also the U.S. dollar index trending near the lowest level since December. The other key auction of the week will be Thursday's seven-year as the others are shorter term in nature that should not present a problem in selling," said Bookvar.

The government on Tuesday plans to sell $42 billion in two-year notes, with MF Global Inc. researcher Nick Kalivas expecting average to lower demand. "The supply may be too much and the leading data suggests foreign interest may be weaker," Kalivas wrote.

Tuesday will also bring the sale of $27 billion in 52-week bills and $30 billion in 4-week bills, followed by $39 billion in five-year notes Wednesday, and $28 billion in seven-year notes on Thursday.

"I am not hoping the auctions go poorly, but people worry whether or not these things will be fully subscribed," Peter Cecchini, a partner at Seven Bridges Management, said in a phone interview on Friday.