Insights 
VT 
The U.S. Treasury plans to auction $70 billion of 5-year notes. The recent 2-year note auction had moderate buying levels, with strong domestic participation but less interest from international buyers.
Data from the past six months reveal certain metrics for these auctions. The tail averaged -0.3 basis points, and the bid-to-cover ratio stood at 2.39 times. Participation included 18.9% from direct buyers, 70.1% from indirect buyers, and 11.0% from dealers.
Watch On Upcoming Auction Results
Based on the tepid foreign interest in the 2-year sale, we are watching the upcoming 5-year auction results closely. While domestic demand has been a strong backstop, any significant drop in the indirect bid below its 70.1% average would signal that global investors are getting wary of U.S. debt levels at current yields. A recent search shows the May 28th 5-year auction actually saw strong demand with a bid-to-cover of 2.49x, but we view this as a temporary reprieve rather than a new trend.
This bond market anxiety is happening while Federal Reserve officials deliver hawkish messages. Minneapolis Fed President Kashkari recently stated he needs to see “many more months” of positive inflation data before considering a rate cut, pouring cold water on hopes for imminent easing. His sentiment reinforces the market’s ‘higher for longer’ stance and suggests the path of least resistance for yields is still upward.
Therefore, we believe derivative traders should consider positions that benefit from stubbornly high or rising interest rates. This includes purchasing puts on long-duration bond ETFs or using options on Secured Overnight Financing Rate (SOFR) futures to bet against near-term rate cuts. According to the CME FedWatch Tool, the market is now pricing in the first full rate cut for November 2024, a significant pushback from earlier expectations.
Implications For Equities And The Dollar
This interest rate outlook creates a defensive posture for equities. We see value in buying protective puts on major stock indices, as higher borrowing costs tend to compress corporate earnings and valuations. We only have to look back to the infamous 7-year Treasury auction in February 2021, which saw a massive spike in yields and triggered a sharp, albeit brief, sell-off in technology stocks.
Finally, the dynamic of weak foreign auction demand, should it reappear, presents a complex scenario for the U.S. dollar. While it may suggest waning confidence in U.S. fiscal health, the resulting global risk-off sentiment could ironically lead to a stronger dollar as capital seeks safety. We are positioning for increased volatility in currency markets, especially in pairs sensitive to U.S. interest rate differentials.
