Wall Street faces the start of a key three-day stretch for the bond market Tuesday as the Treasury begins its run of beefed-up benchmark auctions that could challenge the recent rate-sensitive rally for stocks.
The Treasury, which updated its refunding targets last week, will sell $48 billion in 3-year notes later today, with a $40 billion auction of 10-year notes slated for Wednesday and a $24 billion sales of 30-year bonds penciled-in for Thursday.
The collective $112 billion in new debt, ostensibly to cover just over $102 billion in T-bills maturing on November 15, is also part of the Treasury's broader effort to fund the government's record $1.7 trillion deficit. The auction sizes themselves are the largest since 2021.
Last week, the Treasury cut its current quarter borrowing forecast to by $76 billion, to $776 billion, citing better-than-expected tax receipts from the resilient domestic economy, some of which were deferred as part of disaster relief efforts in California.
Still, markets will need to take down this week's deluge in new coupon-bearing paper, as well as a host of new short-term bills, amid a key inflection point in both Federal Reserve rate forecasts and growth in the broader economy.
"Supply will continue to weigh on the long part of the yield curve for the next six months unless the direction of monetary policy changes." said Saxo Bank senior fixed income strategist Althea Spinozzi in a recent note.
"[Federal Reserve Chairman] seems to believe that the central bank will be able to fight inflation without slowing down the labor market significantly," she added. "However, that comes with the notion that tighter financial conditions must be persistent ... that keeps the door open to further rate hikes."
Tuesday's 3-year auction, however, was reasonably solid, as investor bids totaled around $128.2 billion, or around 2.67 times the amount of offer, with foreign investors taking around 64.6% of the overall sale. Both figures represent solid gains from a similar auction of 3-year notes in early October.
Benchmark 2-year notes were last seen trading at 4.925%, down 12 basis points from last week's pre-Fed decision levels but 3 basis points higher from last night's close following the auction results, while 10-year notes eased to 4.585%.
Related: Fed holds rates steady, hints at more increases but markets see end of hiking cycle
Last week, the Fed held its benchmark rate steady at between 5.25% and 5.5% for a second consecutive meeting, with Chairman Jerome Powell noting "significant" progress in taming inflation and a cooling in the job market.
Those conditions were validated, at least somewhat, in the October jobs report, which showed a slowdown in hiring alongside moderating wage gains. Third quarter labor productivity is also on the rise.
There are signs of a broader economic slowdown, as well, with the Atlanta Fed's GDPNow forecasting tool suggesting a current quarter growth rate of just 1.2%, well south of the 4.9% recorded over the three months ending in September, while private-sector activity surveys, and muted near-term forecasts from the world's biggest tech companies, continue to suggest rough seas ahead.
Inflation on the wane
That would normally trigger an uptick in bond-buying, as investors park cash in the now richly-paying safety of the U.S. Treasury market as they prepared for what could be at least a mild recession arriving in the middle of next year.
The downward slide in headline consumer price pressures, which were last pegged at 3.7% in September, should be another bond -buying inducement, given that fixed income investors are acutely sensitive to inflation rates that erode the value of their future payment streams.
Those dynamics powered last week's sharp rally across the Treasury curve, which saw 30-year bonds fall the most since the Covid pandemic and 10-year notes diving below the 4.5% mark.
Stocks, in concert, had their best week of the year, with the S&P 500 rising 5.825% and the rate-sensitive Nasdaq surging 6.6%.
Related: Jobs report shows marked slowdown; jobless rate highest since January
This week, however, an under-reported nugget in the Fed's third quarter Senior Loan Officers' Survey is nudging yields higher. The report noted that, even with the recent surge in market rates, some banks are actually easing lending conditions, providing fresh credit lines to an already solid economy.
The Fed, for its part, had hoped that higher Treasury yields (a proxy for higher borrowing rates) would tighten financial conditions, slow credit growth and, as a result, act as a circuit-breaker for the broader economy and its underlying inflation pressures.
A series of developments in overseas markets, including the Bank of Japan's decision to allow for higher yields on governments bonds (making them more attractive to domestic investors) as well as the ongoing 'de-dollarization' of China's currency reserves, has put foreign demand for new Treasury sales in question.
Weakened foreign demand
Last month, indirect bidders – which mostly comprise foreign central banks – took down just 60.3% if a $35 billion auction of 10-year notes, down from 66.3% at the prior sale in early September.
Foreign buyers of the $51 billion 2-year note auction in late October, meanwhile, purchased 62% of the $51 billion sale, down from the 65% figure reported in September and below the near-term average of around 65.5%.
The S&P 500 earnings yield, which acts a proxy for the 'premium' investors demand to hold stocks over risk-free Treasury bonds, was last pegged at around 4.07%, the lowest in 2-years, and 53 basis points south of the current 10-year yield of 4.585%.
Weak demand in any of the three auctions this week, pared with new messaging from the Fed that it still has work to do with respect to bringing down inflation, could trigger another move lower in bond prices, and a corresponding jump in Treasury yields, making equities even less-attractive to risk-wary investors.
And as we've seen time and again this year, that could easily translate into notable pullback for stocks heading into the holiday break.
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