Bond Prices Take Back Ground; Solid 3-Year Sale Sets Stage for 10-Years

US Treasury prices closed near the highs having spent the session working back from the early lows with the long bond paring its earlier lead while the 2-year lagged significantly. The market was able to easily swallow the week’s first big Treasury auction. The May producer price index (PPI) was largely in line with consensus, although the headline 12-month measure fell short.

The $38 billion 3-year auction fared will even as yields tracked the lowest levels since 2017 with buyers taking a lower yield. Demand was “stellar,” according to the folks at Zerohedge, with overall demand the strongest since September and foreign buyers stepped in for the most since December 2017.

Wednesday has some bigger ticket items on the agenda with the May consumer price index (CPI) which is expected to soften and will be another indicator that will guide expectations for when the Federal Reserve may start cutting rates.

There will also be a reopened $24 billion 10-year note auction on tap. The impressive 3-year sale may raise the bar on expectations for the 10-years, which, like the previous 3-year auction, also had a poor showing in May.

The 30-year yield went out near 2.617% from 2.613% low, opening 2.653% high and 2.621% close Monday. The 10-year yield settled near 2.14% versus a 2.138% low, 2.175% high and 2.141% close Monday. The 5-year yield went out near 1.91% against a 1.906% low, 1.944% high and 1.911% close. The 2-year yield settled on the 1.922% low from a 1.944% high and 1.90% close.

The curve trade settled flatter with the 2-and 10-year yield differential near 21.8 from 24.1 Monday while the 5-and 30-year yield spread tightened to near 70.7 from 71.1. The 3-month to -10-year yield spread remained in inverted territory but pulled back from the deeper levels and continued to add to its near 2-week streak.

CME Group fed fund futures traders made a slight adjustment to the view on expected rate cuts, with the odds of an at-least 25 basis point easing by year-end to near 96.5% versus 98% Monday and 63.5% May 10.

ZH said of the sale that it was impressive overall “with stellar demand, which confirms that no matter how low rates drop, demand remains in an indication that buyers are convinced that rates are going far lower in the coming years.”

The 3-year sale was awarded at 1.861% stopping through the 1.867% reported at the deadline versus 2.248% at the May 7 sale. The yield marked the lowest level since November 2017. Overall demand resulted in a 2.62 bid-to-cover ratio against 2.48 in May and a 2.57 average. Foreign participation took 56.6% from the 37.9% and a 45.3% average. Dealers were left with 30% the lowest since August 2017.

Analysts with Action Economics said that the recent soft data readings, especially on inflation, would see the market boost expectations for Fed rate cuts. Action said the weak May jobs data added fuel to the markets’ simmering fears that a recession is coming, allowing Fed rate cut expectations to burn brighter in recent days.

The Treasury will auction $40 billion 4- and $35 billion 8-week bills Thursday, unchanged from the June 6 sales.

The PPI headline and core were up 0.1% and 0.2%, respectively, as expected. The headline year-over-year however came in at 1.8% against 2% consensus, dragged on by tanking energy prices.

The May National Federation of Independent Business optimism index was up 1.4% at 105.0 after rising 1.7% in April to 103.5.

Wednesday’s calendar offers the weekly Mortgage Bankers’ Association applications index at 7 am ET. The May CPI is due at 8:30 am and the May Treasury budget is due at 2 pm.

The results of the Treasury 10-year auction are due at 1 pm.

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