Preview: US to sell USD 39bln of 10-year notes at 18:00BST/13:00EDT

US 10YR AUCTION RECENT HISTORY:

• High Yield: (prev. 4.468%, six-auction avg. 4.232%)
• Tail: (prev. 0.4bps, six-auction avg. 0.6bps)
• Bid-to-Cover: (prev. 2.40x, six-auction avg. 2.44x)
• Dealers: (prev. 12.0%, six-auction avg. 11.4%)
• Directs: (prev. 24.1%, six-auction avg. 21.1%)
• Indirects: (prev. 64.0%, six-auction avg. 67.6%)

Primer

The US Treasury will sell USD 39bln of 10-year notes with yields currently trading at 4.54%, above both the prior auction's 4.468% high yield and the six-auction average of 4.232%. While yields remain below the 4.69% peak seen in late May, investors are still being offered one of the highest outright yield levels of the past year.

Despite the pullback in energy prices, yields have remained elevated following strong US economic data, most notably the May nonfarm payrolls report, which reinforced the view that the labour market remains stable, if not outright strong. This has allowed the Fed to focus more heavily on the inflation side of its mandate, with money markets now fully pricing one 25bp rate hike by year-end. The stronger labour market backdrop has also reduced concerns about near-term economic weakness, potentially making current yield levels more attractive for real money investors.

The geopolitical backdrop also appears somewhat more constructive. While strikes between Israel and Iran over the weekend and again overnight highlight how fluid the situation remains, reports continue to suggest negotiations are active despite the latest escalation. Markets remain sensitive to developments given their influence on energy prices and inflation expectations.

The auction follows the May CPI report, which was broadly mixed. Core CPI M/M came in softer than expected, while the headline and annual measures were largely in line with forecasts. However, some of the underlying details, including core services Y/Y and supercore inflation, remained firm. Nevertheless, the release removes a key event risk ahead of today's auction. The PPI report remains due on Thursday, but investors now have greater clarity around the inflation backdrop than they did ahead of yesterday's 3-year sale.

The prior 10-year auction was broadly average despite the higher yield environment and lower volatility backdrop. Today, yields trade at similar levels, although the MOVE index has risen to 77 from around 70 at the time of the May offering. The increase in volatility may temper demand somewhat, but the removal of CPI uncertainty and the still-attractive outright yield level could help support participation.

Overall, the auction benefits from elevated yield levels and reduced event risk following CPI. However, the increase in volatility relative to the prior offering may limit the extent of any improvement in demand.