US Treasury yield spike in short span fuels speculation about cause

• Traders suggest technical error, interest rate hedge as possible causes
• Massive 10-year futures sale rumored to be a 'fat finger' mistake
• Incident may have contributed to poorly-received 10-year US Treasury auction

NEW YORK, Aug 6 (Reuters) - A spike in U.S. Treasury yields across the curve in the late morning session on Wednesday caused speculation about what was behind the move.

Some traders suggested it could have been a technical error, while others said it could have been due to an interest rate hedge for a corporate bond issue. Reuters could not verify the cause of the move.

One U.S. rates trader said the sudden surge in yields may have been due to a "fat finger" mistake, or an unintentional typing or input error in the futures market. U.S. Treasury yields on two-year notes to 30-year bonds jumped, caused by what could have been massive selling in the futures market, analysts said.

Tom di Galoma, managing director of rates and trading at Mischler Financial in Park City, Utah, said there was market speculation that someone sold 80,000 contracts in 10-year bond futures, after intending to sell 8,000, after which the trade was speculated to be canceled.

"Selling of 80,000 in 10-year futures is massive. It's like 20 times the size of a normal transaction," di Galoma said, noting that the average size of 10-year future sales is about 5,000 contracts with a maximum of around 20,000 contracts.

He estimated that the sale of 80,000 contracts was equivalent to between $8 billion to $10 billion, a large sum for one transaction in the $27 trillion U.S. Treasury market.

As a result, the U.S. 10-year yield jumped to 4.282% US10YT=RR, from 4.225% or a six basis-point rise in five minutes. That was a sharp increase in that time span given the Treasury market is in a low volatility environment.

A U.S. rate strategist, however, speculated that the spike could be attributed to a "rate lock" going through ahead of a corporate bond issue. Wall Street dealers typically look to lock in borrowing costs for these deals that they underwrite. As part of that process, a dealer sells Treasuries or Treasury futures as a hedge to lock in the borrowing cost on the bond issue before the deal is completed.

The episode happened as dealers and hedge funds began hedging for Wednesday's $42 billion 10-year Treasury note auction. The auction was poorly-received and this late morning incident in the futures market could have contributed to the weak outcome.

"We did have volatility early in the day when we had that big spike due to a large selling in the futures market," said Jan Nevruzi, U.S. rates strategist at TD Securities in New York.

He added that might have caused buyers to pull back at the auction.

BMO in a research note said Wednesday was typical of an August trading session, "low volumes with a midday selloff that triggered more questions than answers."