Powell to bring surprises next week? Strong demand for 2-year US Treasury bond sales, record overseas buying pressure

Investors are flocking to the two-year bonds sold by the US Department of the Treasury, which strongly demonstrates their confidence in the Fed's interest rate cuts starting this year.

Among the three categories of bidders at the auction on Tuesday, the two categories of bidders composed of investors were allocated 91%, setting a record high since 2003. The third category of bidders (primary dealers) received the remaining 9%, marking a historical low.

The auction size of $69 billion on Tuesday set a historical record, with a yield of 4.434%, more than two basis points lower than the pre-auction trading yield before 1 p.m. New York time (the bidding deadline). This marks the lowest yield for a two-year Treasury auction since January, when the auction size was $60 billion.

John Canavan, an analyst at Oxford Economics, said that the prospects for the Fed laying the groundwork for a rate cut in September next week "sustained strong front-end demand this month, which carried through to this afternoon's auction".

The yield on the two-year Treasury bond peaked above 5% at the end of April, but has steadily declined as pricing in rate futures for at least two 25-basis-point rate cuts by the Fed starting in September 2024 emerged.

Fed policymakers are set to meet at the end of July, which would mark the eighth consecutive meeting where they keep the policy rate unchanged, signaling a year-long maintenance of the current 5.25%-5.5% rate range. Financial blog Ling Hedge Point Review stated that the strong demand at Tuesday's Treasury auction indicates that ahead of the Federal Open Market Committee (FOMC) decision next week, the market, especially foreign official institutions, are buying short-term Treasuries in record numbers, almost as if someone knows that contrary to expectations of no rate cut, Powell may bring a surprise next week.

The significant difference between expected and realized yields for investors since 2019 highlights the demand for two-year Treasury sales. With the Fed rate cut looming, the size of money market funds is close to a record $6.154 trillion, which is one of the reasons for the strong two-year Treasury sales.

Ian Lyngen, head of US rate strategy at BMO Capital Markets, wrote in a note: "There is still a lot of cash in money markets and bills, which is consistent with the view that investors are now entering the market to lock in future two-year returns. Intuitively, as the certainty of a recent rate cut prospect increases, primary market supply will be welcomed."

In late trading after the first auction of the week, front-end yields approached intraday lows. The Treasury will continue to sell bonds this week, with a $70 billion five-year bond auction on Wednesday and a $44 billion seven-year bond auction on Thursday The market is still waiting for key data later this week, including the latest on the US economic growth report and the inflation indicators favored by the Federal Reserve.

Kanawan from the Oxford Economics Research Institute said, "There is usually a strong correlation between the intensity of indirect bidding and the demand from domestic investment funds. It seems that investment funds may have been seeking to enter the market before the expected rate cut later this year." He added that the situation will become clearer when the quota numbers from the auction on August 7 expire