Traders work on the floor of the New York Stock Exchange.
NYSE
Stock traders don’t normally talk about bond auctions, but all week the 10-year Treasury auction taking place on Wednesday has been the main topic of discussion.
“It’s been a long time since stock traders cared about bond auctions,” Miller Tabak’s Matt Maley told me. “The main problem for the stock market now is bond yields.”
This belief is widely held on the street: With the reopening story now largely priced in stocks, interest rates are the marginal mover of the markets.
You could smell the panic among stock traders as the 10-year yield rose from 1.1% to 1.5% in less than two weeks at the end of February, causing technology stocks to shrink. Some bond guards predicted interest rates could rise to 2%.
If further stock gains depend on prices, have they peaked? The 10-year-old Treasury has made several runs to break out more than 1.6% and failed. That gives some investors hope that the run-up is over.
Much depends on the outcome of Wednesday’s 10-year auction at 1 p.m. ET. Some stock bulls believe demand will be strong, especially from foreign buyers like the Japanese, whose 10-year return is 0.1%.
Guy Lebas, chief fixed income strategist at Janney Capital Markets, said foreign demand for US Treasuries is and will remain strong.
“What matters is the pace of the increases rather than the actual returns,” he told me. “We had a pretty rapid increase in yields in late February and early March and that was causing a lot of indigestion. If prices fall as they have, demand will increase and the process will slow down.”
This also applies to foreign buyers.
“A lot of US Treasury bonds are held by foreign entities, it’s about 40% of all Treasury Bonds outstanding,” he told me. “A lot of those buyers hedge the currency risk, so what they care about is the return after hedging. Right now you get 1.5% over the 10-year period and you get 20 basis points over the currency hedge, so that’s 1, 7%. That is a very attractive return for foreign buyers. There is no place in the world where you can get 1.7% on a currency hedging basis. “
That sounds like music to the ears of stock bulls, who also hope that one of the biggest concerns about rising bond yields – inflation – will also soon subside.
“Whatever price increases we see for commodities are due to pent-up demand and because the supply chain is stressed,” said Alec Young, chief investment officer at Tactical Alpha. “But every time the equilibrium gets back on the line, you will see prices fall again. Price increases are the result of the reopening, not the long-term inflation, and the bond market has overreacted.”
Still, even Young believes the 10-year auction will be the main driver of the market. “A lot of traders will probably stay until the auction,” Maley told me.
What if the auction keeps rates around the 1.5% level? That will – for Alec Young – be a sign that it is much safer to go back to technology.
“Investors want to own technology,” he told me. “There is no deep loyalty to most of the reopening names. Nobody wants to overthrow Carnival Cruise Lines, or United Airlines, or even Chevron. They want technology.”