The US Treasury recently held an auction for $69 billion in 2-year notes, achieving a high yield of 3.641%. Just before the auction, the WI level was 3.656%, resulting in a tail of -1.5 basis points, compared to a 6-month average of -0.4 basis points. The bid-to-cover ratio was 2.69, exceeding the 6-month average of 2.59. Direct bids were 33.16% of the total, rising from the previous average of 23.0%. Indirect bids made up 68.95%, higher than the average of 66.1%. Dealer bids accounted for 9.74% of the total, which is below the 6-month average of 10.9%. Overall, the auction received an A grade, indicating strong demand for these notes.

Strong Market Conviction

The high demand for 2-year notes, reflected by the notable -1.5 basis point tail, shows strong market conviction. Bidders were eager and accepted a lower yield than what was available just before the auction. This suggests that investors are anticipating lower interest rates soon. Recent economic data supports this view. The July 2025 CPI report showed core inflation dropped to 2.8%, moving closer to the Federal Reserve’s target. Additionally, last month’s disappointing jobs report, which added only 95,000 new jobs, gives the Fed the flexibility to think about rate cuts later in the year.

Investment Strategies for Traders

For traders in derivatives, focusing on falling short-term yields should be a top priority. We recommend going long on futures contracts linked to the SOFR rate, especially those expiring in late 2025 or early 2026. These positions will benefit if the Federal Reserve reduces rates or if the market continues to expect such cuts. Another strategy involves the yield curve. Given the strong demand at the front end, there’s a good chance the yield curve will steepen if long-term inflation fears persist. Traders can take advantage of this “bull steepener” by buying 2-year Treasury note futures while selling 10-year note futures. Looking back, this market behavior marks a big shift from the rate-hiking fears that dominated trading in 2023 and much of 2024. The high demand at this auction indicates that bond market volatility may decrease as the Fed’s approach becomes clearer. Therefore, options strategies that aim to profit from falling volatility, like selling straddles on Treasury futures or buying puts on the MOVE Index, could be effective. Create your live VT Markets account and start trading now.

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