Treasuries Set for Smooth Auctions Even as Caution Abounds

Treasuries rallied as this week’s debt auctions kicked off, adding to confidence that the market can digest supply unscathed.

The U.S. sold $60 billion two-year notes on Tuesday and received solid demand. This auction will be followed by offerings of five-year debt Wednesday and seven-year notes Thursday. Tuesday yields on seven-year Treasuries fell 5 basis points to about 1.3%, mirroring declines across the curve. It’s a far cry from price action in the run-up to last month’s disastrous sale, when yields were already up 14 basis points ahead of the auction deadline.

Treasury yields are pulling back from pandemic-era highs seen last week, aided by renewed demand for havens amid turmoil in Turkey and extended lockdowns in Europe. That’s prompting some strategists to reconsider the extent of the selloff, helping shore up sentiment heading into this week’s sales.

“Weak auctions are almost always overblown -- they simply tell you that at that time, on that day, there wasn’t as much demand as expected,” said Mike Riddell, portfolio manager at Allianz Global Investors. “You can’t read much into the seven-year auction disaster either, because this came at a time of near unprecedented rates volatility.”

Read More: Treasury Strategists Weigh Fading the Selloff: Research Roundup

Fed Comments

Treasury’s 2-year note sale Tuesday came at a yield of 0.152%, matching that traded in the when-issued market just before bidding for the debt ended. Total bids amounted to 2.54 times the amount of debt offered, with this so-called bid-to-cover ratio above the 2.44 level of the February sale.

Federal Reserve Chairman Jerome Powell said the U.S. economic recovery has exceeded expectations, though it’s far from complete, in prepared testimony to the House Financial Services Committee. He and Treasury Secretary Janet Yellen kicked off two days of congressional hearings Tuesday assessing the economic policy response to the Covid-19 crisis.

The 10-year note yield remained lower as Powell and Yellen began to answer questions from committee members. The benchmark yield hovers at about 1.65%, down about 5 basis points on the day.

“We might see some upward pressure on prices” over the course of this year,” Powell said. “Our best view, is that the effect on inflation will be neither particularly large nor persistent.”

The outlook for the pace of consumer prices over the next decade as measured by the gap between inflation-linked and plain vanilla Treasuries held steady at about 2.32% following Powell’s comment in his views of the path of price pressures. The 10-year so-called breakeven rate has risen from as low last year as 0.47%.

In forecasts released last week, Fed policy makers projected that the economy will grow 6.5% in 2021. It has also said it will keep short-term interest rates pinned near zero until the labor market has reached maximum employment and inflation has risen to 2%

While Tuesday’s sale went without a hitch, Aberdeen Standard Investments money manager James Athey says its successors later this week may encounter more of a challenge.

“Investor caution around Treasury supply events is likely to remain elevated,” Athey said. “The dovish stance of the Fed with respect to rate policy is somewhat supportive for shorter dated Treasuries, while their comfort with rising yields at the long end on top of rising growth and inflation expectations create a much less conducive environment for the belly.”

Quarter-end rebalancing flows may also affect markets over the remainder of this month. Bank of America strategists warn that in light of the rally in equities and the sharp bond selloff, flows could be large and “out of equities into fixed income.”

Seven-Year Weakness

Pre-auction weakness set the tone for February’s seven-year sale, which saw the smallest bid-to-cover ratio on record. Allotment data released in March show foreign demand had plummeted to just 8%, the lowest since at least 2009. The equivalent for domestic investors fell to 49%, its lowest since May 2020.

Treasuries Set for Smooth Auctions Even as Caution Abounds

Contrary to the narrative that demand was already stalling, the six-month moving average of foreign interest had been in an uptrend, while the domestic measure was stable. That suggests the slump in buy orders may have been a one-off event, with investors probably spooked by the significant volatility on the day.

Treasuries Set for Smooth Auctions Even as Caution Abounds

A successful seven-year auction may signal the market is stabilizing after three months of rising yields, said Chris Iggo, chief investment officer of core investments at AXA Investment Managers.

“If not, then the Fed has more to do in terms of messaging and it would add to the argument that 10-year benchmark yields will go through 2%,” he said.

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