Treasury auctions are usually mundane affairs, but Wednesdays could upset or break the stock market
Traders work on the trading floor of the New York Stock Exchange.
Stock traders don’t usually talk about bond auctions, but throughout the week the main topic of conversation was the 10-year Treasury auction, which will take place on Wednesday.
“It’s been a long time since stock traders ran bond auctions,” said Matt Maley of Miller Tabak. “Number one for the stock market now is bond yields.”
That belief is widespread on the streets: with the reopening story now largely priced into stocks, interest rates are the marginal engine of the markets.
You could smell the panic among stock traders as the 10-year yield rose from 1.1% to 1.5% in less than two weeks in late February, causing tech stocks to tank. Some bond watchers predicted that yields could move towards 2%.
If more stock rallies depend on interest rates, have they peaked? The 10-year Treasury Department has made multiple attempts to break above 1.6% and has failed. This gives some investors hope that the ramp-up is over.
Much depends on the outcome of the 10-year auction on Wednesday at 1 p.m. Some stock bulls believe demand will be strong, especially from overseas buyers like the Japanese, whose 10-year return is 0.1%.
Guy Lebas, chief fixed income strategist at Janney Capital Markets, said foreign demand for US Treasuries is and will remain strong.
“What matters is the pace of increases rather than actual returns,” he told me. “We had a pretty quick spike in yields in late February and early March and that caused a lot of indigestion. When prices go down as they are, more demand comes in and slows the process down.”
This includes foreign buyers.
“A lot of US Treasury bonds are owned by foreign companies, about 40% of all outstanding Treasuries,” he told me. “A lot of these buyers hedge the currency risk. So they take care of the after-hedge return. Right now you get 1.5% for the 10-year return and 20 basis points for the currency hedge, so that’s 1.7%.” That’s a very attractive return for overseas buyers. There is nowhere in the world where you can get 1.7% on a currency-hedged basis. “
This is music to the ears of the stock bulls, who are also hoping that one of the main concerns about rising bond yields – inflation – will also quickly calm down.
“Whatever raw material price increases are due to pent-up demand and stressed supply chains,” said Alec Young, chief investment officer at Tactical Alpha. “But when the balance is brought back into line, prices will fall again. Price increases are due to reopening, not long-term inflation, and the bond market has overreacted.”
Even so, Young himself believes that the 10-year auction will be the main engine of the market. “A lot of dealers will likely sit on their hands by the time the auction takes place,” said Maley.
What if the auction keeps interest rates close to the 1.5% level? For Alec Young, this will be a sign that it is much safer to get back into technology.
“Investors want to own technology,” he told me. “There’s no deep loyalty to most reopening names. Nobody wants to surpass Carnival Cruise Lines, United Airlines, or even Chevron. They want technology.”