The U.S. Treasury sold benchmark 10-year notes at the highest auction yield since 2011 Wednesday, Treasury data indicated, but demand for the $23 billion auction fell to lowest since February, suggesting the recent rise in global fixed income markets is failing to attract investors.
The Treasury sold $23 billion of its existing 10-year bond, maturing in 2028, with an average yield of 3.225%, the highest since May 2011. So-called direct bidders, comprised of primary dealers, hedge funds, pension investors, took 5.4% of the sale. The so-called bid-to-cover ratio, a key metric for demand, slipped to 2.39, meaning $2,390 was bid for every $1,000 worth of paper on offer. That compares to a recent average of 2.55. Earlier Wednesday, the Treasury’s $36 billion auction of 3-year notes, which drew a yield of 2.898%, had the weakest bid-to-cover ratio — 2.56 — since July.
However, indirect bidders in the 10-year sale, which normally includes global central banks and other foreign investors, were awarded the biggest share of the auction since July, 64.5%, likely attracted by the sharp yield differential between the 10-year notes at 3.225% and benchmark 10-year German bunds, which yield only 0.55%.
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U.S. stocks pared declines modestly following the auction results, only to resume selling once the data had been digested, with the Dow Jones Industrial Average falling 550 points by 3:05 pm eastern, the biggest single-day decline since late March, and the S&P 500 retreating 62.5 points, or 2.07%, on track for its longest losing streak in at least two years.
This week’s $230 billion worth of bond sales, which will wrap up tomorrow with the auction of $16 billion in 30-year paper, marks one of the sternest tests yet to a market that appears ready to either stretch benchmark 10-year yields to 3.6% and beyond in the face of accelerating inflation or retreat to 3% amid questions over the pace of global economic growth and the spillover impact from the ongoing U.S.-China trade war.
However, there’s a growing chorus of views that suggest the recent moves in bond yields, which have taken 10-year notes to the highest since 2011, are masking the fact that bets on future fed rate hikes haven’t really changed and growth could slow next year and beyond as the impact from tax cuts and corporate earnings gains fades.
“Despite stellar US data, investors are concerned about recession risks,” wrote Bank of America Merrill Lynch in a recent research note. “We see further room for curve flattening. After the violent Treasury market moves, Fed hike expectations and inflation expectations have not adjusted enough.”
In fact, BAML notes that investors “are already starting to price in Fed cuts two years from now” and argued that “it’s still reasonable to put on such trades if one believes economic growth will be in question and the market will need to reprice the Fed’s policy path.”
Count the International Monetary Fund among those who may question the Fed’s ability to reach a 3% neutral rate. The Fund trimmed its U.S. and global growth forecasts Tuesday during an international event in Bali, warning that “U.S. growth will decline once parts of its fiscal stimulus go into reverse,”
“Notwithstanding the present demand momentum, we have downgraded our 2019 U.S. growth forecast owing to the recently enacted tariffs on a wide range of imports from China and China’s retaliation,” IMF chief economist Maurice Obstfeld said in a statement.
The Fund’s global growth assessment was trimmed by 2 percentage points to 3.7% for this year and next, while its World Economic Outlook update said U.S. growth will likely hit 2.7% next year, down from a previous assessment of 2.9%. China’s economy, the second largest in the world, will ease to 6.2% from a previous forecast of 6.4%.
Both the U.S. and China assessments for 2018 were left unchanged and 2.9% and 6.6% respectively, with the Fund saying that tit-for-tat tariffs, currently applied to around $300 billion worth of goods, likely won’t hit growth metrics until 2019.