Wall Street Stuck With Bond-Auction Slack as June Fed in Focusby
Higher-than-expected Treasury yields signal investor unease
Market is pricing in almost 80% odds of hike next month
Hawkish messages from some Federal Reserve officials may have cost U.S. taxpayers during the Treasury’s $62 billion of note and bond auctions this week.
In a sign that investors took a dim view of buying the government’s debt before next month’s Fed meeting, Wall Street dealers were stuck with the largest share since September of the Treasury’s $15 billion 30-year bond sale Thursday. They also had to absorb a larger-than-usual amount of Wednesday’s $23 billion 10-year offering. Primary dealers are obligated to bid at auctions, leaving them to soak up the excess when investors stand back.
Putting aside November, when bonds were plunging in the wake of the election, it’s been more than two years since this pair of auctions yielded so much more than the market expected, data compiled by Bloomberg show. The 10-year offering even drew a reaction from DoubleLine Capital’s Jeffrey Gundlach, who deemed it “lousy” on Twitter.
To Aaron Kohli at BMO Capital Markets and Thomas Simons at Jefferies LLC, the feeble results come down to a Fed that appears intent on proceeding with rate hikes and reducing its balance sheet.
One of the most hawkish statements yet came Wednesday, when Boston Fed President Eric Rosengren signaled he favors raising rates three more times this year, a pace that would exceed the three total 2017 hikes policy makers projected in March. Also this week, Kansas City Fed President Esther George said the central bank should start shrinking its balance sheet this year.
The “Fed certainly played a part in this and hawkish speak has been a theme for them,” said Kohli, a fixed-income strategist at BMO. “It’s difficult to own Treasuries heading into a hawkish Fed meeting where they could bring up tapering.”
The $24 billion three-year note sale Tuesday showed investor concern that the central bank will raise rates at a faster clip. The maturity, among the most sensitive to Fed policy, drew a yield of 1.572 percent, the second-highest over the past seven years. Last month it dipped as low as 1.35 percent, which would be below the midpoint of the fed funds target range after two more hikes.
Investors are getting wary on the long end too. The 30-year yield is poised to increase for the fourth straight week, the longest stretch since March 2016.
“The data that we got this week, the Fedspeak we got recently, suggests that the reversal of the Trump trade is slightly overdone from the Fed’s perspective,” said Simons, an economist at Jefferies. “It seems like they’re trying to combat that a bit with more aggressively hawkish guidance.”
As long as the Fed stays on message, dealers may face larger allocations as others pull back. Indirect bidders, a class of investors that includes foreign central banks and mutual funds, in recent years have taken more than half of each longer-term auction.
Jim Vogel at FTN Financial said the group made “a passing grade” with a 59 percent share of the 30-year bonds, though it’s “nothing to brag about.”
Fed officials are standing firm in their views, and the market is listening, pricing in an almost 80 percent chance of a hike in June, judging by the current effective fed funds rate and the forward overnight index swap rate. That view got support from data Thursday showing continuing U.S. jobless claims fell to a 28-year low.
The combination of Fed signals and evidence of economic strength could herald more weak auctions, Simons said.
“Dealers had to take down more than they had to in some time,” Simons said. “My sense is that’s something that might continue.”