(Bloomberg) — US Treasuries sank after investors spurned an auction on concern that a protracted war in the Middle East will lead to an oil-driven resurgence in inflation.
Losses deepened on Tuesday after a $69 billion sale of two-year notes drew unexpectedly weak demand, and as the Wall Street Journal reported that the US is planning to deploy about 3,000 troops to the Middle East. Two-year yields rose by as much as 10 basis points to 3.96%, leading yields on all maturities higher as oil prices advanced.
“Today’s auction was unfortunately brought to market in a very difficult, unsettled, unsure period,” said David Robin, an interest-rate strategist at TJM Institutional Services LLC. “Why commit? Risk-reward is heavily skewed to risk versus reward.”
Before the auction at 1 p.m. New York time, Treasury yields were higher by two to four basis points on the day, tracking a rise in the price of oil. Crude prices have been the bond market’s dominant driver since they began spiraling higher at the end of last month because of their potential to boost inflation gauges via retail gasoline.
The two-year notes were awarded at 3.936%, higher than their yield in pre-auction trading just before the bidding deadline, a sign that demand fell short of expectations. The result was the highest two-year auction yield since May. The previous two-year note auction on Feb. 24 produced the lowest yield since 2022.
Along with the outright yield, the auction was expected to benefit from having cheapened relative to longer-maturity tenors. Its yield is about 47 basis points lower than the 10-year note’s yield. As recently as early February it was more than 70 basis points lower.
Other auction metrics were also weak. The 26 primary dealers, whose participation in Treasury auctions is required, were awarded 24.1% of the sale, the most in three years, as some investors steered clear. Total bids were 2.44 times the amount being offered, the lowest ratio since May 2024.
Meanwhile, there were indications of a large short base in the two-year sector, a possible source of demand for the sale.
It was the first of three Treasury fixed-rate debt auctions this week, with the market still facing $70 billion of five-year notes on Wednesday and $44 billion of seven-year notes on Thursday.
Prevailing yields for Treasuries with two years to maturity have climbed by about half a percentage point since the end of February as the prospect of higher inflation has wiped out expectations that the Federal Reserve will lower interest rates this year.
“Elevated oil prices have kept alive the small pricing for a Fed rate hike this year, and the uncertainty pushed potential auction demand to the sidelines for now,” said John Canavan, lead analyst at Oxford Economics. “The Treasury selloff appears to be primarily a knee-jerk reaction to the ugly auction results, although I believe the weak auction demand is due in part to higher oil prices.”
As recently as the end of February, short-term interest-rate products fully priced in two quarter-point rate cuts by the US central bank by year-end. They no longer price in any, and have begun to price in a small chance that its next move will be to raise rates.
–With assistance from Michael MacKenzie.
(Adds comment, other auction metrics and context and updates yield levels.)
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