Bond Yields Slide After Solid Start to Auction Week; Inflation Eases - TheStreet

U.S. Treasury yields tumbled Tuesday following the first of three key test for the bond market this week as the government plans for the sale of $120 billion in new debt.

The Treasury sold $58 billion in 3-year notes at an auction-high yield of 0.335%, with foreign demand falling just below average at 47.8%. Overall demand for the new paper, however, was solid, with bidders seeking $2.69 for every $1 on offer from the government, the highest since June of 2018. A crucial auction of $38 billion in 10-year notes follows Wednesday with a $24 billion sale of 30-year bonds wrapping up the weekly fund period on Thursday. 

Benchmark 10-year notes were last seen around 5 basis points lower from yesterday's levels at 1.554% by mid-day, while the yield on 2-year notes was little-changed at 0.169%.

This week's sales -- part of a $274 billion quarterly funding target that was established before the Senate passed President Joe Biden's $1.9 trillion COVID relief bill -- comes amid a modest easing of inflation expectations even as investors look to a faster-than-expected post pandemic recovery and oil prices hover at the highest levels in more than two years. 

The so-called breakeven rate between five-year Treasury bonds and five-year inflation protected securities, a key market gauge for consumer price increases, was marked at 2.38%m down from the 2008 high of 2.5% it hit last Wednesday but still firmly ahead of the Fed's 2% inflation target.

Treasury Secretary Janet Yellen told MSNBC Monday that faster inflation isn't necessarily a by-product of the record stimulus bill.

“If it turns out to be inflationary, there are tools to deal with that," she insisted. 

Inflation is considered the so-called "enemy of bonds" because it erodes the value of future payments, which are the bedrock of fixed income securities. And its effect is even more pronounced on longer-term bonds, which the Treasury is likely to rely on in the coming years as part of its borrowing plans.

In fact, the new spending commitments, alongside legacy costs linked to tax cuts, will mean the Treasury will likely issue a record net of $1.84 trillion in new bonds this year, according to JPMorgan Chase, a figure that's more than four times last year's total.

Stocks took their sharpest downward turn late last month when the yield on benchmark 10-year notes topped the expected dividend yield on the S&P 500, a move that challenges the attraction of equities over bonds for longer-focused investors.

With around 95% of the S&P 500 reporting profits for the December quarter, earnings are expected to rise 4.1% from the same period in 2019 and then rebound to a 22% growth rate over the three months ending in March. 

That said, stocks are trading at notably high valuations, with the collective S&P 500 P/E ratio sitting at 25.35, well ahead of the five-year average of 15.3, and the overtaking of the divided yield could trigger further concerns for near-term stock performance. 

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