Bond Traders Seek a New Kind of 3% at Treasury's 10-Year Auction

(Bloomberg) -- Bond traders’ obsession with the 3 percent level on 10-year Treasuries may see a new wrinkle at Wednesday’s $25 billion auction of the maturity.

The benchmark Treasury yield hit that key psychological level in the cash market last month for the first time since early 2014. And while that was an achievement, it’s been almost seven years since investors were able to purchase 10-year notes with a fixed 3 percent coupon at auction.

They could very well get that chance at the 1 p.m. New York time offering, if Treasuries sell off a bit more. The 10-year yield rose above 3 percent during Asia trading Wednesday for the first time in two weeks, and was trading at 3.0080 percent at 6:30 a.m. in New York. How the market reacts to the higher rate may help Wall Street settle the debate over whether the bond-market selloff has run its course for now. It’s a question that’s taken on added significance as the government is ramping up auctions to finance swelling deficits.

“We’re still near the highs in yields, and if we can get to 3 again and strike a 3 percent coupon, does that bring in a lot of demand for the auctions?” said George Goncalves, head of Americas fixed-income strategy at Nomura. To him, that rate “would be welcomed by the value investors.”

According to Treasury’s rules, the yield at an auction of new securities can’t be below the coupon. In other words, the department will issue debt at either par or a discount, meaning a lower price and a higher yield than the stated interest rate. In the case of the 10-year note, that coupon is then locked in for reopenings in the subsequent two months of the quarter. It was 2.75 percent at the past three sales.

Two-Year Drama

The interest-rate drama can be seen in the price action before sales. Treasury’s two-year auction on April 24 looked like it had a chance to draw a 2.5 percent coupon, with the yield reaching as high as 2.4955 percent intraday. Yet as it became clear it wouldn’t cross the threshold, the yield fell, and hasn’t budged much since then.

No matter what happens, the 10-year yield is poised to be the highest at auction since at least January 2014, when it reached 3.009 percent. The previous high mark set this year was 2.889 percent in March.

Reaching the 3 percent level may be necessary to draw investors, because the Labor Department releases consumer-price data the following day, Goncalves said. The core measure is expected to reach 2.2 percent on an annual basis, the highest since early 2017, and within striking distance of the fastest pace of growth since the end of the recession.

Nothing ‘Scary’

“If we have either decent CPI or nothing really that scary, then maybe we rally afterwards,” Goncalves said. He added that President Donald Trump’s withdrawal from the Iran nuclear deal could complicate matters heading into the auction. “I’m really watching for the follow-through.”

For DoubleLine Capital Chief Investment Officer Jeffrey Gundlach, a core CPI reading well above 2.25 percent would signal “a real change in attitude” regarding inflation, he said on a webcast Tuesday.

Last month’s 10-year auction had a lower yield than March’s sale, and demand was lackluster. Foreign and international investors purchased just 12.8 percent of the offering, the lowest share since September, Treasury data show. The class of buyers known as indirect bidders, in total, took the least since November 2016.

In Tuesday’s three-year note sale, Treasury saw similar apathy from indirect bidders, who took the smallest share of the maturity since December 2016.

Perhaps Jim Caron at Morgan Stanley Investment Management had it right when he was thinking about the auctions last week: “To get people interested and excited, you have to be over 3 percent,” he said.

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