Investors fear new Treasury auctions could trigger another wave of selling

Investors are bracing for a trio of large US government debt auctions this week, after a recent sale of seven-year notes flopped and sparked a frenzied trading wave.

The Treasury Department is expected to issue $ 120 billion in new bonds starting Tuesday, selling $ 58 billion in three-year notes, $ 38 billion in 10-year debt, and $ 24 billion in 30-year debt.

The auction comes at a tenuous time for bond markets, which have been beset by volatility as investors position themselves for higher inflation, stronger growth and the Federal Reserve’s outlook for pushing forward its hike schedule. interest rate. The Senate’s passage over the weekend of the $ 1.9 billion stimulus bill, worth about 8% of U.S. gross domestic product according to Goldman Sachs, reinforced that argument, analysts say. .

“Investors will be short of pins and needles until the auction is over,” said Gennadiy Goldberg, rate strategist at TD Securities.

“The fear is that one of these auctions will be just as bad or worse than the seven-year period, which will trigger another round of sales. . . which then leads to a new wave of market instability, and then all of a sudden we go back to shopping.

Large auctions, especially for longer-dated T-bills, have become the norm since the start of the pandemic, as the government seeks to fund historic stimulus packages passed by U.S. lawmakers since March. Last year, investors absorbed the record supply with ease – with the exception of a few little hiccup. And as fund managers demanded to hold debt, yields hit new all-time lows.

That changed last month, following a grim $ 62 billion auction seven year notes February 25. Investors have pulled out of the market in droves, forcing primary dealers – who guarantee sales of US bonds – to resume much of the selling, exacerbating already wobbly trading conditions.

As prices fell, yields on benchmark 10-year Treasuries briefly exceeded 1.6 percent, after trading around 1.4 percent earlier this week. It is now back up to 1.6 percent, after another selloff early Monday.

Market movements of this magnitude are remarkable for the US $ 21 billion public debt market, given its stature as the world’s largest and most liquid bond market. Weak auctions are also attracting close scrutiny, and the current environment has left investors hesitant about a potential repeat.

“People cannot tell that what happened [on February 25] will not happen again, ”said a managing director of the rates division of a major US bank, adding that they were“ increasingly concerned ”about the market’s ability to absorb the huge amount of supply that was going to flood the market this year.

The Federal Reserve remains the biggest buyer of Treasuries

While Padhraic Garvey, Global Head of Debt and Interest Rate Strategy at ING, expects upcoming auctions to see higher demand – given that current yield levels are higher and therefore much more attractive for buyers just a few weeks ago – he warned that any sign of weakness could have wider ramifications.

“[If] the market is showing severe indigestion, which would give the market more ammunition to increase yields, ”he said.

Investors seeking insurance from the Federal Reserve have been left want to last week, after President Jay Powell failed to forcefully push back the recent increase in Treasury yields.

“Until investors are comfortable with knowing the Fed’s tolerance for higher rates, it is unlikely that most [Treasury] buyers will want to “ catch the falling knife ” for more [Treasury] yields, ”said Meghan Swiber, rate strategist at Bank of America.

Given the Fed’s reluctance to penetrate deeper into the treasury market beyond its $ 80 billion-per-month asset purchase program, it warned of “significant” supply and demand . imbalance long-term Treasuries would persist and keep upward pressure on rates.

A key source of demand – foreign buyers – has already withdrawn from the market. Recent data from the Japanese Ministry of Finance shows that during the two weeks ending Feb.26, Japanese funds sold $ 34 billion in foreign bonds, most of which, according to BMO Capital Markets’ Ian Lyngen, were likely treasury bills. While market participants note that this is typical before the country’s upcoming fiscal year close, it remains an open question to what extent these players will return.

“As a community, foreign real money can be very meaningful because it can help build trust,” said Deirdre Dunn, global co-director of rates at Citigroup. “With a shortage of activity. . . it may be more difficult for the market to find its place. “

Banks have become another important buyer of the Treasury, but their activity in the market may also be more limited. US regulators must decide by the end of the month to expand a temporary change to the so-called additional leverage ratio (SLR) rules, which allows banks to exclude treasury bills and cash reserves when calculating the additional capital they need to hold. The policy was put in place in April 2020 in part to encourage banks to intervene more aggressively to stabilize volatile markets.

“The idea that things could move further is in recent memory,” said Dylan Roy, global co-director of fixed income operations at UBS. “Dealers who believe that the SLR might not be extended may have concerns, which could have negative effects on the functioning of the market and overall liquidity.”

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