Insights into this week's US Treasury refunding: 3-, 10-, and 30-year overview.

Summary:

• This week’s three- and ten-year auctions are likely to draw solid demand. Despite record large auctions size, the risk-reward offered by these tenors is favorable amidst the macroeconomic backdrop.
• Monitor the 30-year tenor for duration demand. The 30-year tenor might offer crucial insights into investors’ duration preferences. Given persistent inflation, extending duration remains a directional bet on disinflation pressures and early rate cuts.
• Robust duration demand could drive 10-year yields down to 4.31%. Yet, as inflation remains sticky a rebound above 4.5% in 10-year yields is likely.

Anticipated Market Dynamics.

The US Treasury is set to auction $125 billion worth of coupon-bearing US Treasuries this week, spanning 3-, 10-, and 30-year tenors. Encouragingly, May brings with it $286 billion in coupon redemptions, $154 billion of which are due next week, bolstering demand and likely resulting in robust bidding metrics despite ongoing quantitative tightening (QT) operating at full speed this month, with plans for a slowdown next month.

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 is poised to reach record highs, their risk-reward profile 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 the 30-year bonds is distinct, carrying the highest duration in the US yield curve and offering a yield lower than those in the front end of the curve. Extending duration at a time when inflation remains persistent suggests a directional bet on swift disinflation pressures, likely leading to early and aggressive rate cuts.

Interestingly, over the past two years, 10-year US Treasury auctions have often tailed When-Issued trading, with only four 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?

This week will test the demand for duration. The positive sentiment prevailing in bond markets comes at a time when supply is entering the market. Following the release of weaker-than-expected nonfarm payrolls data, bond markets have adjusted their expectations, now pricing in two rate cuts by year-end, compared to nearly one cut just days earlier. This shift has resulted in lower yields across the yield curve.

Should strong bidding metrics and a stop-through occur for the 10- and 30-year notes, it could amplify the rally, potentially driving 10-year yields down to 4.31%.

Conversely, if bidding metrics are weak, particularly concerning longer-duration issues, we might observe further bear-steepening of the yield curve.

As divergence between the yield price and RSI suggests, the former is more likely. Yet from a mid-term perspective yields are likely to continue to rise if inflation remains sticky.