Treasury auction in focus as 10-year sale tests demand, inflation outlook

The U.S. Treasury will auction $36 billion in new 10-year notes Wednesday, just hours before the Federal Reserve publishes details of its September rate decision and a day ahead of a key inflation reading from the Commerce Department. 

The benchmark sale, part of the Treasury's expanded funding remit that will see it auction around $103 billion in new paper each quarter, comes amid historic volatility in the bond market and increasing concern over the fiscal stance of the U.S. government, which lost another triple-A credit rating earlier this year and was called-out by the International Monetary Fund in its annual World Economic Outlook.

Demand for the notes, however, is expected to be solid, even with the broader market uncertainty over the Fed's 'higher for longer' rate stance, as investors are now extending bets that the end of its policy tightening cycle ended with its last quarter point increase in July.

Last month, investors placed bids worth around $88.2 billion for the $35 billion in new paper on offer, a figure that converts to a bid-to-cover ratio of around 2.52, down modestly from the prior two sales in July and August, although yields at the time were near the highest levels since 2007, making the bond particularly attractive to overseas investors. 

Benchmark 10-year notes were last seen trading at 4.592% in early New York dealing, down from last week's 2007 high of 4.895%, with 2-year paper pegged at 4.957%.

Minutes of the Fed's September meeting, where it held rates steady at 5.25% to 5.5%, will likely shed light on the central bank's near-term policy stance, although recent signals from Fed officials suggest the recent surge in Treasury yields, which lifted 10-year notes to a 2007 high of 4.895% last week, are having a restrictive impact on the broader economy and have likely negated the need for another rate hike. 

The Commerce Department will also publish its estimate of September inflation before the market opens on Thursday , with analysts looking for core CPI, the Fed's favored focus, to slow to 4.1% from 4.3% in August. That level, however, would remain more than double the central bank's preferred 2% target. 

"We believe the current high level of the 10-year Treasury yield is unsustainable given that the Federal Reserve is close to or finished with their rate hike campaign and the recent bond yield surge has actually accomplished most of the work for the Fed," said James Demmert, chief investment officer at New York-based Main Street Research. "The 10-year Treasury yield is likely to decline in coming weeks and months, which is a very bullish setup for global stocks."

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