Why Treasury Auctions Matter More Than CPI, FOMC Meetings

The S&P 500 remained relatively unchanged today as market participants eagerly awaited the final Fed meeting of 2023, closely watching for any hints on potential interest rate cuts.

While the S&P 500 stayed near the flatline, the Nasdaq experienced a slight decline of 0.3%. By contrast, the Dow Jones Industrial Average saw an uptick, gaining 82 points, or 0.2%.

In the retail sector, Macy’s shares surged over 16% following news of a $5.8 billion buyout proposal. On the tech front, giants such as Apple and Nvidia experienced declines of 1.7% and 2.2%, respectively, contributing to the Nasdaq’s downward pressure. Meta Platforms’ shares also saw a decrease, ticking down by 3%.

The focus is now on the Federal Reserve, which is widely expected to keep the fed funds rate steady within the 5.25%-5.5% range. Markets are keenly awaiting Chair Jerome Powell’s press conference on Wednesday, where he is anticipated to reaffirm his commitment to curbing inflation. Current market indicators from the CME Group’s FedWatch tool suggest a 45% probability of a 0.25 percentage point rate cut by the Fed in March.

Chris Larkin, head of trading and investing at E-Trade, noted, “No one expects a hike, but hotter-than-expected inflation readings could throw cold water on the idea that rate cuts are coming sooner rather than later.”

Both the S&P 500 and Nasdaq are riding the momentum of six consecutive weeks of gains. This week, key inflation data releases are on the horizon, with the November consumer price index scheduled for Tuesday and the producer price index set for Wednesday. These reports could significantly influence market dynamics and the Fed’s decisions on rate cuts.

In the bond market, the day witnessed a 3-year Treasury auction, which concluded with less-than-ideal outcomes for bond bulls. The auction priced at a high yield of 4.49%, a notable decrease from last month’s 4.701% and the lowest since August. However, it didn’t meet market expectations, as indicated by a 1.7bps tail, tied for the biggest since February’s record 4bps tail.

The auction’s bid-to-cover ratio dropped significantly to 2.416, well below the recent average of 2.743 and the lowest since February 2023. Internally, the demand from foreign accounts (Indirects) took a hit, only accounting for 52.1% of the auction, a decrease from 64.6% last month and the lowest since June 2022. With Directs taking 21.7%, Dealers were left with a substantial 26.2%, a considerable increase from last month’s 16.3% and the six-auction average of 16.1%.

This disappointing auction outcome has led to a rise in 10-year Treasury yields to session highs of 4.28%, an almost 20bps increase from Thursday’s low of 4.10%. This shift suggests a growing realization in the market that financial conditions had been eased excessively in anticipation of the upcoming Fed meeting.

In essence, when Treasurys surged through November, they undid the Fed’s last two hikes. Yields fell as a result, but this may only be a slight reprieve; massive government spending will keep debt issuances very high for the foreseeable future. And, the more Treasurys that are issued, the lower prices will go unless these Treasury auctions have enough willing buyers.

Today’s 3-year Treasury auction did not, and the 10-year probably won’t be any better. So, even if the Fed does start cutting rates early next year (they probably will), poor Treasury auctions would push rates higher, anyway. It’s like stepping on the gas with one foot and stomping on the brakes with another.

This is making the “soft landing” hypothesis tough to swallow for some traders, as the government would ironically spend the US into higher rates, thus a recession, a year after massive spending in 2023 kept the economy above water. There is no free lunch, and every economy will have to pay the piper, eventually. These Treasury auctions are indicative of that, and they’re going to be some of the most-watched events next year, surpassing perhaps even CPI or FOMC days as yields inevitably start to scream higher again.


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