Quarterly Outlook
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Bond auction update: CPI numbers don’t move bonds, but weak demand leaves US Treasuries volatile
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Although today's surprise in CPI figures was priced in US Treasuries, we believe that demand for the US safe-havens remains weak, exposing investors to selloff risk. Everything points to a smooth 30-year US Treasury auction today. However, there is a chance to see a selloff in Treasuries if the bid-to-cover ratio is below 2.1x. We expect an uptick in demand only when 10-year yields rise to 2%. In the meantime, Italy saw solid demand for 3- and 15-year bonds, indicating that investors are ready for more and longer BTPS issuances. The 50-year Gilts reopening in the UK was successful. Still, bidding metrics were weaker than February despite the higher yield offered, indicating that investors are wary of duration.
Today's CPI numbers surprised at 2.6% YoY versus 2.5% expected. The move was fully priced in the bond market; thus, volatility was contained, paving the way for a smooth 30-year auction. Yet, we believe that yesterday’s 3- and 10-year bond auctions have highlighted a problem: demand for US Treasury remains weak. Indeed, both bonds' bid-to-cover ratio and foreign bids were below their one-year averages. It means that the market is still on hedge and that investors are ready to dump US Treasuries amid any surprise.
All in all, the auction results are depressive news for bond bulls, especially for those holding bonds with high duration. Hence, we believe there is still the possibility that today's 30-year US Treasury auction could go south.
Following are today's 30-year auction possible scenarios:
- “Apocalypse now”: bid-to-cover below 2.1x, the lowest since 2018. It can trigger a deep selloff in US Treasuries that will push 10-year yields to test 1.75%
- “Chill out”: bid-to-cover between 2.1x and 2.30x showing that the music is not stopping, but bond investors remain nervous, waiting for another day to dump US Treasuries
The latter looks likely today. However, it's imperative to accept that an apocalyptic scenario is doomed to happen as economic and inflation pressures accelerate. We expect that the 10-year yield will hit 2% by summer. Only then US Treasury will find real support from foreign investors.
Demand for Italian BTPS remains solid. Are we going to see new ultras?
In the old continent, we saw Italy issuing 3-, 5- and 15-year BTPS this morning. Despite last week Draghi announced that the country would increase its debt by EUR 40 billion, demand for BTPS was solid with a bid-to-cover ratio slightly below the 5-year average. Additionally, the Italian Treasury issued almost double the amount of 15-year bonds it did in December, without hiccups.
The auction results strengthen our view that Italy continues to be in a position of strength and that the market could easily digest any issuance of Italian ultra-long debt beyond 50-years.
Although Italian government bond yields remain a couple of basis points higher on the day, BTPS are still Europe's best-performing government bonds. Today, 15-year BTPS yields rose to the highest level since October 2020, widening just 20 basis points since the beginning of the year. Comparatively, French 15-year bond yields rose 50 basis points year to date.
Positive sentiment in Italian government bonds can be explained by the entrance of Draghi in the country's politics and by the higher yield that they provide compared to peers.
Appetite for ultras is tested by 2071 Gilts reopening
The United Kingdom reopened the 50-year bond issuance with 2071 maturity amid good demand from long-term real money investors. Bidding metrics were solid but below the auction of February the 2nd, which saw the Debt Management Office issuing the same Gilts at 0.74% in yield. Today, the same bonds were sold with a yield of 1.11%. It shows that despite Gilts offer higher yields compared to a few months back; investors remain wary of duration amid rising yields in the United States.
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