Insights into This Week's U.S. Treasury Auctions: 3-, 10-, and 30-Year Tenor Overview and Market Dynamics.

Summary:

• This week’s three- and ten-year auctions are expected to attract strong demand due to the favorable risk-reward profile amid the current weakening macroeconomic momentum.
• The 30-year auction is anticipated to also see robust demand driven by (1) ongoing economic slowdown, (2) persistent disinflationary trends, (3) a slowdown in Quantitative Tightening, limiting the runoffs under the Fed’s balance sheet, and (4) a smaller auction size compared to the other two tenors.
• Robust demand for longer durations could drive 10- and 30-year yields down to test support levels at 4.18% and 4.32%, respectively. However, in the long run, duration will remain vulnerable to a potential re-acceleration of the U.S. economy. This scenario is plausible if the Fed begins to cut rates while fiscal spending remains elevated.

An economic slowdown and ongoing disinflation are expected to support the long end of the yield curve.

The US Treasury is set to auction $119 billion worth of coupon-bearing US Treasuries this week, spanning 3-, 10-, and 30-year tenors. Encouragingly, July brings with it $189.84 billion in coupon redemptions, $67.55 billion of which are due next week from U.S. Treasuries with a 3-year tenor at issuance, bolstering demand and likely resulting in robust bidding metrics.

We anticipate positive market reception for the 3- and 10-year US Treasury auctions, while exercising caution regarding the 30-year tenor. Although the auction size for the 3- and 10-year Treasuries remains at high levels for a reopening, the risk-reward profile of these securities appears compelling amidst a continuously evolving macroeconomic landscape. This should position the notes favorably to capitalize on upcoming redemptions and potential rotation from riskier assets.

In contrast, the proposition presented by 30-year bonds is more directional, as these securities have the highest duration in the US yield curve and offer a lower yield compared to short-term US Treasuries. However, demand for ultra-long duration is likely to be supported by Chair Powell’s upcoming testimony in Congress, where he is expected to highlight progress on the inflation front and the approaching time to cut rates.

Additionally, the 30-year US Treasury auction comes on the back of June’s CPI data, where the headline yearly figure is anticipated to drop from 3.3% to 3.1%, while the core yearly reading is expected to remain at 3.4%. This could fuel expectations of imminent rate cuts, benefiting high-duration instruments.

Supporting the long end of the yield curve is also the recent slowdown in Quantitative Tightening (QT). In July, approximately $55 billion in coupon redemption is expected under the Federal Reserve balance sheet. With the old QT cap on US Treasuries at $60 billion, all maturing coupon bonds in July would have been phased out. However, with the new cap of $25 billion, $30 billion will need to be reinvested in US Treasuries, providing overall support to these securities.

Interestingly, over the past two years, 10-year US Treasury auctions have often tailed When-Issued, with only five months seeing stop-throughs. Conversely, stop-throughs are more frequent in the 3- and 30-year tenors, with 30-year auctions experiencing tails in 11 out of 24 instances. The outperformance of 30-year auctions over 10-year auctions may be attributed to their smaller size, which mitigates the risk of tail.

What implications does this hold for bond markets?

U.S. Treasuries are likely to be supported throughout the summer. With the economy slowing, as highlighted by the latest job report, the Federal Reserve slowing down QT, and policymakers considering rate cuts, a rally in U.S. Treasuries seems inevitable. Currently, 10- and 30-year yields are in a downtrend, but they will need to break below support levels of 4.18% and 4.32%, respectively, to confirm this trend.

It's important to note the risk that US Treasury yields could rise if upcoming CPI reports indicate that inflation is stalling in its progress toward the Fed's 2% target or even showing signs of acceleration. In such a scenario, 10-year yields might rise to test resistance at 4.47% and 30-year yields could test 4.86%. However, with policymakers reassuring that significant progress has been made in fighting inflation and that it will continue, it's difficult to envision yields spiking this summer.

However, long-term investors should consider whether a short-term rally in US Treasuries will be sustainable in the long run. The possibility of an economic acceleration once the Fed begins to cut rates is not remote, especially if the stock market continues to reach new highs.