As tensions between the US and Iran continue to escalate, Wall Street is issuing a stark warning to the market in the most direct way possible—a poorly received US Treasury auction.
On Tuesday, March 24, the US Treasury's auction of $69 billion in two-year notes met with unexpectedly weak demand, with foreign investors largely absent. The notes finally sold at a yield of 3.936%, higher than the yield in the secondary market just before the auction closed. This resulted in the largest "tail" since March 2023, highlighting weak investor appetite.
In a related development, reports indicated that elements of the US Army's 82nd Airborne Division are being deployed to the Middle East. These dual factors pushed the yield on the two-year Treasury note up by as much as 10 basis points to 3.96%, a near eight-month high, and drove yields higher across the curve.
David Robin, an interest rate strategist at TJM Institutional Services, attributed the weak auction result to a highly uncertain market environment: "Today's auction unfortunately came at a very difficult, volatile, and unknown time. Why step in now? The risk-reward ratio is heavily skewed toward risk."
It is worth noting that after the US market closed on Tuesday, reports emerged quoting former President Donald Trump as saying that US-Iran negotiations "may be quite close to an agreement" and that Iran had agreed to never possess nuclear weapons. The reports also suggested the US proposed a one-month ceasefire and a 15-point peace plan. Treasury yields subsequently retreated, partially erasing the day's gains, and oil prices fell in after-hours trading. However, this did not fundamentally alter the market's cautious tone, with a $70 billion five-year note auction scheduled for Wednesday and a $44 billion seven-year note auction set for Thursday.
Rising oil prices are fueling inflation concerns and have led to a complete reversal of expectations for interest rate cuts. The yield achieved in this auction was the highest for a two-year note sale since May. Just one month earlier, the previous two-year auction on February 24 had produced the lowest yield since 2022. The root cause is the ongoing Middle East conflict, which is keeping oil prices elevated, rekindling inflation expectations, and nearly extinguishing hopes for Federal Reserve rate cuts this year. The market has even begun pricing in the possibility of a rate hike.
John Canavan, Chief Analyst at Oxford Economics, pointed out: "High oil prices are sustaining the market's modest pricing for a Fed rate hike this year. The uncertainty is also causing potential auction demand to stay on the sidelines for now." He added, "The sell-off in Treasuries is partly a knee-jerk reaction to the poor auction result, but the weak auction demand itself is also partly a consequence of high oil prices."
Anthony Saglimbene, Chief Market Strategist at Ameriprise, noted: "High oil prices are already exerting tangible pressure on the US economy through rising prices and weaker employment. Until there is more clarity on the situation in the Middle East, particularly concerning the Strait of Hormuz, equity markets will remain under pressure."
The rise in Treasury yields across the board also implies higher borrowing costs and tighter financial conditions, creating a direct drag on both businesses and consumers. With approximately $10 trillion in US debt scheduled to mature and need refinancing within the next year, the pressure from rising borrowing costs is significant. Two-year Treasury notes are typically the most sensitive to monetary policy expectations and should attract safe-haven flows during a Fed easing cycle. However, the fact that yields are rising instead of falling, coupled with significantly weaker auction demand, clearly indicates a shift in investor judgment regarding the policy outlook. As Anthony Saglimbene stated, "The market is beginning to doubt that things will be resolved so easily."