Preview: US to sell USD 44bln of 7-year notes at 18:00BST / 13:00EDT

Auction History

7-year

• Tail: (prev. 0.0bps, six-auction average 0.2bps)
• High Yield: (prev. 4.512%, six-auction average 4.328%)
• B/C: (prev. 2.50x, six-auction average 2.49x)
• Dealer: (prev. 12.3%, six-auction average 12.1%)
• Direct: (prev. 27.0%, six-auction average 23.3%)
• Indirect: (prev. 60.8%, six-auction average 64.6%)

Primer

The US Treasury will sell USD 44bln of 7yr notes on September 24th, to settle September 30th.

The 7-year auction will be seen as a test following an average 2-year auction on Tuesday and a woeful 5-year auction on Wednesday. Yields have risen substantially since the last auction, with the 7-year yield trading around 5.05% versus the previous high yield of 4.52%. However, the 2- and 5-year auctions were also offered following substantial backups in yields, which failed to generate particularly strong demand. Direct participation rose at both auctions, but was not enough to offset weaker indirect demand. Elsewhere in recent supply, the 20-year auction was weak, while the 10- and 30-year offerings were very strong and the 3-year was solid.

There has been little tier-one US data released this week, although Wednesday's S&P Global Flash PMI report was strong and helped drive the latest move higher in yields. Manufacturing, Services and the Composite all rose by more than expected, while the report was accompanied by hawkish commentary on inflation. The September FOMC decision last week was also hawkish, with the dots signalling another hike by year-end, while Chair Warsh maintained a strong emphasis on returning inflation to target. Subsequent Fed commentary has largely reinforced the inflation focus. Governor Barr explicitly said further rate hikes are likely needed, while others have pencilled in another hike by year-end. Goolsbee and Musalem have also voiced concerns around inflation, particularly the potential for demand-driven price pressures.

Treasuries initially sold off following last week's Fed decision, despite the 25bp hike being widely expected, before much of the move reversed the following day as participants focused on improved Fed credibility and its commitment to restoring price stability. However, yields have since resumed their move higher and remain substantially elevated compared with the previous auction cycle.

The 7-year auction sits in the belly of the curve and is therefore not directly impacted by the Treasury's enhanced long-end buyback operations. Both the 10-20yr and 20-30yr operations have recently seen their maximum sizes increased to USD 6bln.

Regarding volatility, the MOVE index has surged following Wednesday's rates sell-off and currently trades around 95, up from 79 earlier in the week and roughly 72 at the time of the August offering.

Overall, although the substantial increase in outright yields provides investors with considerably more yield than at the August auction, the poor reception of Wednesday's 5-year and only average 2-year auction suggests that higher yields alone may not be sufficient to generate strong demand. The sharp rise in the MOVE index also presents a less favourable backdrop for the auction. On the other hand, the policy outlook is somewhat clearer than it was in August following the September FOMC decision and updated SEPs, while there is no tier-one US data due this week. However, event risk picks up again next week with August PCE and September NFP.