The U.S. Treasury is set to auction $70 billion in 5-year notes. The recent auction for 2-year notes saw moderate interest, with strong participation from U.S. investors but less engagement from international buyers. Over the past six months, here are some key stats from these auctions: – The tail averaged -0.3 basis points. – The bid-to-cover ratio was 2.39 times. – Participation included 18.9% from direct buyers, 70.1% from indirect buyers, and 11.0% from dealers.

Watch Upcoming Auction Results

Given the low foreign interest in the recent 2-year auction, we are keeping a close eye on the upcoming 5-year auction results. Domestic demand has been strong, but if the indirect bid drops significantly below its average of 70.1%, it might indicate that global investors are starting to doubt U.S. debt levels at current yields. Notably, the May 28th 5-year auction had solid demand with a bid-to-cover of 2.49x, but we view this as a temporary spike, not a new trend. This uncertainty in the bond market coincides with statements from Federal Reserve officials. Minneapolis Fed President Kashkari recently said he needs to see “many more months” of positive inflation data before thinking about a rate cut, dampening hopes for an imminent reduction. His comments support the market’s “higher for longer” viewpoint, suggesting that yields may continue to rise. As a result, we recommend that derivative traders consider options that profit from persistently high or increasing interest rates. This could involve buying puts on long-duration bond ETFs or using options on Secured Overnight Financing Rate (SOFR) futures to bet against near-term rate cuts. According to the CME FedWatch Tool, the market is now expecting the first full rate cut in November 2024, which is a significant delay from previous predictions.

Implications for Equities and the Dollar

This outlook on interest rates creates a cautious environment for equities. We see value in purchasing protective puts on major stock indices, as higher borrowing costs can reduce corporate earnings and valuations. For instance, the 7-year Treasury auction in February 2021 caused a sharp, if brief, sell-off in technology stocks due to a surge in yields. Additionally, if we see continued weak foreign demand in upcoming auctions, it poses a complicated scenario for the U.S. dollar. While this might reflect declining confidence in U.S. fiscal health, it could also lead to a stronger dollar as investors seek safety during global risk-off sentiments. We are preparing for increased volatility in currency markets, particularly for pairs sensitive to U.S. interest rate changes. Create your live VT Markets account and start trading now.

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