(Bloomberg) -- US Treasuries fell as demand for haven assets waned globally, with the rise in yields helping smooth a $58 billion auction of three-year notes in afternoon trade.
Yields jumped at least nine basis points across the curve, with the two-year yield at one stage rising above 4%. Investor demand for the new three-year notes at 1 p.m. New York time was solid, with the rate on bonds with a similar maturity above 3.8% after sliding to the lowest in more than a year on Monday.
“It was a decent auction and the market consolidation off the yield lows since yesterday has helped,” said Gregory Faranello, head of US rates trading and strategy for AmeriVet Securities.
It’s a rapid turnaround in sentiment. Signs of slowing growth, coupled with a violent selloff in risk assets had spurred speculation the Federal Reserve could cut interest rates aggressively to aid the world’s largest economy. The two-year yield, which at one point fell 23 basis points on Monday, rebounded as much as 10 basis points on Tuesday.
“Sentiment may very well be overshooting,” said Jack Janasiewicz, a portfolio strategist at Natixis Investment Managers. “Evidence certainly points to a slowing economy. But slowing and slow are two very different points.”
Traders are also moderating expectations of deep Fed rate cuts this year. Swaps point to about 106 basis points of easing, compared to as much as 150 basis points on Monday. An emergency cut as soon as this month has fallen back out of favor.
Tuesday’s three-year Treasury auction was the first of the August-to-October quarter and poised to become the first this year to draw a yield under 4%. The new issue was awarded at 3.810% versus the 3.812% when-issued yield at the 1 p.m. New York time bidding deadline after a selloff that lifted its yield by more than 8 basis points on the day. The bid-to-cover ratio of 2.55 was slightly below the one-year average, while the indirect participation of non-dealer buyers at 64.4% was seen marginally above average.
This week’s US auction cycle also includes a $42 billion 10-year note on Wednesday and a $25 billion 30-year bond Thursday. These longer-dated maturities will provide an important test of demand given the market’s rally since the Fed’s July meeting.
“The rate market doesn’t look cheap here,” said AmeriVet’s Faranello, adding that Treasury debt sales over the coming days will likely require higher yields by way of a concession for buyers. The market has “work to do at these levels,” he said.
Murky Outlook
Global bonds rallied sharply on Monday as investors worried about whether an economic recession in the US was imminent. Almost every risk asset was sold and a surging Japanese yen sparked an unwind of carry trades.
The moves eased later in the day as data showing the US services sector expanded in July helped allay some of the market’s concerns about an abrupt downturn. Central bankers and economists were also quick to downplay the risks.
San Francisco Fed President Mary Daly said she still sees strength in the jobs market with most companies not yet cutting jobs. Economist Claudia Sahm, who has observed that unemployment rate increases like the one in July usually indicate a recession is under way, said the US economy had arrived at this point in “a position of strength.”
For Amundi SA, the US economy will go through an “orderly slowdown” as corporate and household balance sheets are strong and central banks will be proactive in supporting activity. Recent moves have left government bonds looking less attractive, the firm’s strategists said.
“Yields are returning toward levels not seen since 2022, when the economic outlook was more gloomy than seems to be the case today,” strategists including Guy Stear wrote in a note.
Investors likely took profits as bonds surged. Positions in US two-, five- and 10-year futures fell on Monday, according to data published by CME Group Inc. Open interest in the Treasury five-year note contract dropped more than 1% to 6.65 million, the biggest decrease in a year after accounting for periods when contracts are rolled on a quarterly basis.
While market moves eased on Tuesday, some investors are preparing for more volatility ahead. BlackRock’s global chief investment strategist Wei Li is worried the Bank of Japan raised the risk of a future policy error by being more hawkish than markets expected.
“This outsized response compared with previous instances of carry trades being quickly unwound suggests there is more at play in Japan than recession fears – and could have global ramifications if it continues,” said Li.
--With assistance from James Hirai, Anchalee Worrachate and Elizabeth Stanton.
(Updates pricing, adds auction quote in third paragraph and results in seventh)
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