US Treasury 10-year note auction could turn ugly on heightened tariff fears

By Gertrude Chavez-Dreyfuss

NEW YORK, April 9 (Reuters) - Investors are likely to steer clear of the U.S. Treasury's auction of $39 billion in benchmark 10-year notes on Wednesday as concerns intensified about a bond market sell-off driven by an escalating trade war between the United States and its major trading partners led by China.

The prospect of a major trade conflict has been looming in the bond market for the last few weeks, sparking worries about demand for what is supposed to be a global safe haven.

The 10-year yield, currently at 4.40% UIS10YT=RR, has surged nearly 45 basis points (bps) this week, the largest weekly increase since November 2001. On Wednesday, the benchmark yield climbed 18.3 bps and was last at 4.44% ahead of the 1300 EDT auction.

"We haven't seen volatility like this since the pandemic. The difference now is we don't know the Federal Reserve's reaction function," said Gregory Faranello, head of U.S. rates, at AmeriVet Securities in New York.

"Ultimately, if the U.S. Treasury market doesn't function, we have issues. You can't have 10-year yields move over 60-basis points in the blink of an eye and think you have a functioning market. Would love to think there's an adult in the room somewhere."

On Tuesday, the U.S. Treasury sold $58 billion in three-year notes and it was poorly received by the market. The note was priced at 3.784%, higher by over 2 bps than what the market indicated, suggesting investors demanded a premium to buy the three-year debt. In bond market parlance, the three-year note auction "tailed".

Dealer participation for the three-year note was 20.7%, according to analysts, sharply up from 11.5% in last month's auction. High dealer participation in Treasury auctions suggests lack of interest from other investors so that dealers had to step in to absorb the note.

It could be similar for the 10-year note sale.

"The combination of limited foreign participation and domestic levered funds likely pulling back risk present a tough backdrop for this sale," wrote Well Fargo in a research note. "Dealer participation above 25% would be very concerning for the market."

Last month's 10-year note auction came in within expectations, with end-user demand stable. The bid-to-cover ratio, another gauge of demand, was 2.59, the highest since December.

Wells Fargo, however, pointed out that 10-year note auctions in April usually tend to be weak.

The last five 10-year reopening auctions had been softer than anticipated, with the largest tail in n 2024 at 3.1 bps. The average tail over the last five years was 1.8 bps, Wells Fargo wrote.