The Treasury market’s nascent rally is facing its next big test: a bond auction that will help gauge whether investors are confident 2023’s selloff is over once and for all.
Spurred by slowing inflation and signs of a cooling growth, traders and investors have recently rushed headlong into US government debt, convinced that the Federal Reserve is done raising interest rates and will shift to cutting them by the middle of next year. That’s ended a a six-month losing streak for Treasuries and pushed the market to a gain of 2.6% in November. It’s the biggest advance since March, when there were fears that a banking crisis would sink the economy.
But this month’s advance has driven yields to the lowest levels since September, turning the demand at Monday’s 20-year auction into an indicator of whether investors see a risk the recent trend will reverse. Such concerns were evident in the 30-year auction earlier this month, when the market briefly tumbled after the Treasury had to offer an unusually large yield premium to sell the securities.
The Treasury’s 20-year bond has been an albatross for much of its three-year existence, during which it has never been sold during the holiday-shortened US Thanksgiving week. So a strong reception would be a particularly powerful endorsement of the rally.
The sale “will be a good sanity check for the notion that the evolution of data has in a meaningful way shifted to more stable/constructive for how duration supply gets absorbed,” said William Marshall, head of US interest-rate strategy at BNP Paribas.
The confidence of traders has been rattled over the past year as the surprisingly strong economy and stubborn inflation quashed several rallies that broke out on speculation the Fed would stop raising interest rates. The swelling federal deficit — which is testing the market’s capacity to absorb all the new debt that’s financing it — has also played a role.
But this month signs that the labor market is cooling and inflation is being reined in has strengthened conviction that the central bank’s monetary policy is sufficiently restrictive. At the same time, the auction size increases the Treasury announced were smaller than many bond dealers expected, particularly for long-maturity offerings, easing some of the supply concerns.
The 30-year bond auction on Nov. 9 nonetheless drew a much higher-than-expected yield, a sign of weak demand that fueled a major selloff in the market that day. That downturn, however, proved brief, rewarding investors as the new bonds went on to rally, sending the yield from a starting level of about 4.77% to as low as 4.56% this past Friday.
While the 20-year Treasury bond has consistently suffered from weak demand — keeping yields above those on 30-year bonds — Marshall said it has been faring better in auctions since the Treasury reduced its size relative to the 10- and 30-year counterparts. Monday’s auction is for $16 billion, compared with $24 billion for the 30-year sale this month.
Even so, the 20-year has failed to keep pace with the Treasury market’s recent gains, a sign of awareness that next week’s auction might otherwise be a hard sell.
“People know next week is going to probably be a volume and liquidity vacuum,” but “you can visualize the market trying to make room for it,” William O’Donnell, rates desk strategist at Citigroup Inc., said about the auction.
“I don’t think supply is going to be the acute problem the market may fear now,” he said. “We could have moments in time when it feels like there’s not enough supply.” That was the case on Tuesday, when the five-year Treasury yield fell as much as 25 basis points in the rally sparked by October consumer price readings.
What Bloomberg’s Strategists Say
Treasuries are poised for double-digit returns in 2024, given the Bloomberg Economics view of the year starting in a recession, followed by a tepid recovery. Treasury demand could overwhelm supply with expectations of easier monetary policy and declining inflation, while federal deficits will continue to be a concern.
—Ira Jersey and Will Hoffman, rates strategists
Click here for the full report
Key US economic indicators in the coming week include October durable goods orders. Globally, purchasing managers indexes for the UK and euro-zone are due out.
Concerns persist, to be sure. This week’s declines in yields owed something to the latest collapse in oil prices, and the Treasury rally ran out of steam on Friday as oil rebounded from the lowest levels since July.
Also, traders may have gotten ahead of themselves by continuing to anticipate that the Fed will pivot to lowering interest rates by June and deliver a total of four quarter-point cuts by December 2024. Fed officials themselves in September anticipated no more than one cut based on their median forecast.
“The risk is that yields move higher as the market prices the easing out, as we have seen before, particularly if the Fed has a bit more cautious rhetoric at the December meeting,” said Leslie Falconio, head of taxable fixed income strategy at UBS Global Wealth Management.
What to Watch
- Economic data calendar
- Nov. 20: Leading Index
- Nov. 21: Chicago Fed National Activity Index, Philadelphia Fed Non-Manufacturing; existing home sales
- Nov. 22: MBA mortgage applications; initial jobless claims; durable goods
- Nov. 23: reading of University of Michigan sentiment;
- Fed calendar:
- Nov 21: Minutes of Nov. 1 FOMC meeting
- Auction calendar:
- Nov. 20: 13- and 26-week bills; 20-year bonds
- Nov. 21: 2-year FRN reopening; 41-day CMB; 10-year TIPS reopening
- Nov. 22: 4-, 8- and 17-week bills
--With assistance from Ye Xie and Edward Bolingbroke.
