Investors flocked to the US Treasury’s monthly sale of two-year notes in a powerful demonstration of faith in Federal Reserve interest-rate cuts beginning this year.
Among the three main categories of bidders for the auction, the two that comprise investors were awarded a combined 91%, the most ever in data going back to 2003. Primary dealers, the third category, were awarded the remaining 9%, a record low.
The $69 billion auction — a record-matching size — was awarded at 4.434%, more than two basis points lower than the notes’ yield in pre-auction trading just before 1 p.m. New York time, the bidding deadline. It was the lowest auction yield for two-year notes since January, when the size was $60 billion.
The prospect that the Fed will lay the groundwork for a September rate cut next week “has sustained this month’s strong front-end demand, and that demand carried over into the auction this afternoon,” said John Canavan, analyst at Oxford Economics.
The two-year yield peaked above 5% in late April and has steadily fallen as interest-rate futures priced in at least two quarter-point rate cuts by the Fed by year-end 2024, starting in September. When central bank policymakers meet at the end of July, they’re seen making no change for an eighth straight meeting, marking a year since the band was increased to the current 5.25%-to-5.5% range.
The scale of demand for the two-year sale was highlighted by the largest divergence between the expected yield and what investors received, based on records compiled since 2019. A near-record of $6.154 trillion sitting in money market funds is also a factor behind the strong two-year sale as Fed rate cuts loom.
“There remains plenty of cash on the sidelines in money markets and bills, which is consistent with the notion that investors are now beginning to move into the coupon curve to lock in returns for the next two years,” Ian Lyngen, head of US rates strategy at BMO Capital Markets wrote in a note. “It follows intuitively that as certainty builds regarding the prospects for a near-term cut, primary market supply will be well-received.”
In late trading, front-end yields were near their session lows in the wake of this week’s first auction. The Treasury will continue this week’s debt sales with $70 billion of five-year notes on Wednesday, followed by $44 billion of seven-year notes on Thursday.
The market also awaits key data later in the week, including a report on the US economy’s growth and an update on the Federal Reserve’s favored gauge of inflation.
“There is usually a solid correlation between the strength of the indirect bid and domestic investment fund demand,” said Oxford Economics’ Canavan, “and it looks like investment funds may have been looking to get in ahead of the expected rate cuts this year.”
More clarity on that will arrive on Aug. 7, when auction allotment figures are due, he added.
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