Tepid Demand for Two-Year Treasury Notes Raises Concerns

The auction of two-year Treasury notes held on Tuesday delivered lackluster results, indicating a decline in investor interest as worries surrounding the federal deficit and interest rates persist.

Auction Details

The U.S. Treasury Department conducted an auction of $51 billion worth of two-year notes on Tuesday afternoon. While investors accepted a yield of 5.055%, which matched expectations, two important measures used to evaluate auctions showed weakness.

Weak Metrics

The bid-to-cover ratio, which measures the number of bids relative to the amount of debt offered, came in at 2.64 times. This was lower than the ratios seen in both September's auction (2.73 times) and August's auction (2.94 times). It also fell below the six-auction average of 2.82 times. Decreasing bid-to-cover ratios typically signal less robust investor interest.

Moreover, primary dealers, who purchase unsold supply, were left with 17.6% of the notes sold. This marked their largest take since April.

Uncertain Outlook

Following a disappointing sale of 30-year bonds earlier this month, the reception for the two-year notes adds to concerns. However, the recent auction of 20-year bonds showed strength.

The tepid response to this week's Treasury offerings sets an uncertain tone for upcoming auctions. On Wednesday and Thursday, five-year and seven-year notes will be up for sale, respectively. Consequently, it appears that investors are mainly focused on the challenges facing both the bond market and the broader economy.

Concerns Rise Over U.S. Debt as Budget Deficit Continues to Mount

The mounting federal budget deficit in the United States has raised concerns among investors. According to data released by the Congressional Budget Office on Oct. 10, the deficit for fiscal 2023 is estimated to reach $1.7 trillion, surpassing last year's $1.4 trillion. This upward trend in spending has resulted in increased issuance of government debt, which has further impacted the market.

SIFMA Research, a renowned tracker of the U.S. Treasury market, reported that the issuance of government bonds as of September 2023 was 26% higher compared to the previous year. This surge in bond supply has likely contributed to investors demanding higher yields, subsequently causing bond prices to fall, given their inverse relationship.

Furthermore, the recent auction faced significant challenges, potentially due to the size of the offering. With an auction size of $51 billion, it surpassed the last month's auction by $3 billion and exceeded previous levels by $9 billion, as outlined by Jay Barry, J.P. Morgan's co-head of U.S. rates strategy.

Investors have also been cautious as they anticipate the Federal Reserve's trajectory for interest rates. Any potential increase in rates could lead to further rises in yields, subsequently diminishing the value of notes. However, the Fed is expected to maintain its current rates at the forthcoming policy-setting meeting in November.

As a result of these factors, Tuesday's auction experienced weak demand, causing the 2-year note to rise by 43 basis points to close at 5.103%. This reaction is typical when demand for bonds is lackluster.