Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Global Head of Macro Strategy
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US three-year note auction points to more turbulence ahead
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Yesterday's 3-year note auction showed weakness in foreign demand, which can be explosive during today's 10-year US Treasury bond sale. If the Consumer Price Index surprises even marginally, there is the possibility to head towards brutal 10- and 30-year auctions, which may push 10-year yields on a fast track to 2%.
Today's 10-year bond auction will be critical to understanding whether US Treasuries' foreign demand increases amid a rise in yields.
David Tepper, the founder of Appaloosa Management, said that the selloff in Treasuries is likely over because foreign investors will start to buy Treasuries at current yield levels. Nevertheless, yesterday's sale of 3-year Treasury notes proved quite the contrary.
Information concerning foreign demand of US government bonds is contained within indirect bidders' data, which in the past few Treasury auctions showed is in decline. News outlets reported that yesterday's 3-year note auction was solid, highlighting that the bid-to-cover ratio was the highest since June 2018. However, when looking at the composition of that demand, the snapshot is troubling. Indeed, while bidding metrics as a whole point to higher demand, indirect award declined to 47.8%. It means that foreign entities are still not buying into US Treasuries despite higher yields.
The sale of 7-year notes on February 25th showed how lack of foreign demand poses a serious threat to US Treasuries. During this auction, indirect bids fell to the lowest since 2014, provoking the yield on 7-year notes to tail by 4.1 basis points, provoking a wider selloff of Treasuries. Despite indirect bidder demand did not plunge as much during yesterday’s 3-year note auction, we believe that it still exhibits bidding metrics weakness which could prove explosive today and tomorrow during the 10- and 30-year bond auctions, especially if the Consumer Price Index comes stronger than expected today.
Economists expect the yearly CPI figure to rise to 1.7% from 1.4% prior, but if inflation surprises even marginally, the bond market's reaction can be brutal.
As highlighted before, 10-year Treasury yields are now trading within a consolidation area between 1.50% and 1.65%. If yields were to break above 1.65%, we might witness another squeeze within the Mortgage-Backed Security (MBS) market that could send the 10-year yields to a fast track towards 2%.
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