Preview: US to sell USD 70bln of 5yr notes at 18:00BST/13:00EDT

US 5-YEAR NOTE RECENT AUCTION HISTORY:

• High Yield: (prev. 4.182%, six-auction avg. 3.884%)
• Tail: (prev. 0.1bps, six-auction avg. 0.5bps)
• Bid-to-Cover: (prev. 2.34x, six-auction avg. 2.33x)
• Dealers: (prev. 12.8%, six-auction avg. 12.3%)
• Directs: (prev. 12.3%, six-auction avg. 22.4%)
• Indirects: (prev. 74.9%, six-auction avg. 65.3%)

Preview

The current 5-year yield trades around 4.25%, above both the prior auction’s high yield of 4.182% and the six-auction average of 3.884%. Yields have moved higher over the past week following a hawkish shift from the FOMC. The Committee removed forward guidance, reinforced its commitment to price stability and delivered a more hawkish set of economic projections, helping support yields in the front-end and belly of the curve. The hawkish Fed has offset some of the downside pressure that would typically accompany the sharp decline in energy prices following the US-Iran memorandum of understanding and the reopening of the Strait of Hormuz.

The BofA MOVE Index briefly retraced all of the US-Iran conflict-related increase before moving back to around 70, broadly matching the level seen at the time of the previous 5-year auction. While volatility remains elevated relative to the start of the year, it is no longer a significant headwind for Treasury demand.

Recent auction results provide mixed but generally constructive signals. The June 3-year auction was slightly soft relative to recent averages, although demand improved from the prior month and both direct and indirect participation increased. Since then, geopolitical uncertainty has eased considerably following the US-Iran agreement. The first nominal coupon auction following the agreement, the 20-year bond sale, was met with very strong demand, suggesting investors were willing to add duration as a major source of uncertainty was removed.

The 2-year auction on Tuesday was also strong, marking the first stop-through in that maturity since January 2026. Demand was driven primarily by an increase in direct participation, while indirect demand softened slightly. The key question for today’s auction is whether the recent backup in yields can entice direct bidders back into the 5-year sector while maintaining the strong foreign participation seen at the previous auction.

The May 5-year auction was mixed overall. The auction tailed by just 0.1bps, an improvement versus both the prior auction and recent averages, while the bid-to-cover ratio and dealer allocation were broadly in line with historical norms. However, direct demand fell well below average levels while indirect participation surged to 74.9%, significantly above the six-auction average of 65.3%. Today’s auction will provide a useful test of whether that unusually strong indirect demand can be sustained and whether domestic buyers return at higher yield levels.

The policy backdrop has also shifted notably since the previous 5-year auction. The June FOMC meeting delivered a clear hawkish message, while the subsequent 5-year TIPS auction attracted exceptionally strong demand. Markets are currently pricing around 37bps of tightening through year-end, fully pricing one 25bp rate hike and assigning roughly a 48% probability to a second. Meanwhile, Bank of America expects the FOMC to deliver three rate hikes this year.

Overall, the auction benefits from a combination of higher outright yields, reduced geopolitical uncertainty and a more hawkish Federal Reserve. The key question will be whether the improved backdrop can bring direct bidders back into the sector while maintaining the strong indirect demand seen at the previous auction. If Tuesday’s 2-year auction is any guide, the recent backup in yields may prove sufficient to attract stronger participation from domestic investors.