Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Weak bidding metrics and rising yields might lead to a disastrous 7-year US Treasury note auction
Althea Spinozzi
Head of Fixed Income Strategy
Summary: Everything points to a brutal 7-year auction, which may provoke a deeper selloff in the secondary bond market. Bidding metrics are quickly deteriorating, and yields are rising fast as investors position for earlier rate hikes. If today's 7-year auction tails a lot, it's safe to assume that the secondary bond market will come under fire, too.
The recent fast rise in yields is draining demand for US Treasuries putting the bond market at risk of another selloff.
Yesterday, the US Treasury sold 2-year and 5-year notes showing a strong deterioration in bidding metrics which might lead to a disastrous 7-year note auction today.
Demand for the 2-year Notes was particularly weak, with the bid-to-cover ratio falling to 2.28x, the lowest level since December 2008, during the Lehman bankruptcy. Indirect bidders plunged to 45.32% from 60.53% in the prior auction causing the yield to tail by 0.08bps pricing at 0.31%, the highest yield since March 2020.
Despite weakness from the 2-year note sale didn’t leak to the following 5-year auction, it’s safe to say that there are signs that demand for US Treasuries is deteriorating. Although the bid-to-cover ratio for the 5-year notes was in line with the year-to-date average, indirect bidders fell from 62.7% in the previous auction to 54.3%, the lowest since March 2020.
Today the selloff continues with 10-year yields trading well above 1.5%. The belly of the curve is rising in a bearish construction, indicating that the market is beginning to position for earlier rate hikes as inflationary pressures increasingly look more permanent. Indeed, the Eurodollar strip is close to showing a rate hike as early as June 2022, and it is already pricing two rate hikes by the end of 2022.
It looks like the perfect explosive mix ahead of a bond auction, which maturity usually is not liked by the market. In February, we witnessed the most brutal 7-year auction in years as the yield curve was selling off on inflation fears (does it ring a bell?). Suppose today's 7-year auction tails a lot. In that case, it's safe to assume that the secondary bond market will come under fire, too, forcing yields even higher.
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