Bond markets back in focus, with 2-year auction on deck, as selloff continues

Updated at 9:38 am EDT

Bond markets are bracing for another series of Treasury auctions this week amid one of the biggest market selloffs in nearly two years that has triggered a surge in yields and renewed concerns over the record U.S. deficit.

The Treasury will sell $51 billion in new 2-year notes later today in the first of three benchmark auctions that will see another $114 billion in paper added to the market just at the time that 10-year notes top the 5% mark for the first time since 2007.

A combination of faster inflation, a hawkish Federal Reserve, a resilient job market and the prospect of deeper government borrowing to fund record fiscal deficits have all combined to push Treasury yields higher, with 2-year notes last seen changing hands at 5.114% – around 70 basis points higher than at the start of the year – ahead of today's sale.

Some investors think there may be more room to run, as well, given that long-dated yields are still trading at a discount to both the current effective Fed Funds rate of 5.33% and the projected rate of 5.6% based on bets of at least one more rate hike over the coming months.

That puts the demand component in today's auction in sharp focus, following a slump in purchases for the Treasury's benchmark 10-year note sale on October 11

Investors placed bids worth $87.5 billion for the $35 billion in paper on offer, a level that represents a so-called bid-to-cover ratio, a key demand indicator, of 2.50, down from 2.52 in September. 

Foreign investors were also reluctant, according to auction data, taking down just 60.3%, down from 66.3% at the prior sale in early September.

That said, data published late Wednesday showed that foreign investors ramped-up their holdings of U.S. Treasuries to the highest levels in 18 months in August, the latest figures available, hovering up $7.707 trillion.

Demand could be tested further into the end of the year, however, after Treasury Secretary Janet Yellen publishes her quarterly refunding report on November 1 – also the day of the next Fed rate decision – which will outline the size of benchmark auctions, as well as the overall debt-raising mandate, heading into 2024.

• Get investment guidance from trusted portfolio managers without the management fees. Sign up for Action Alerts PLUS now.