The function of yield is to create demand. And it did.
By Wolf Richter for WOLF STREET.
The 20-year Treasury bond auction today was a doozie. It took a yield of 5.42% to find enough demand to sell all of the $13 billion of bonds, the highest yield since the 20-year bond was re-introduced in March 2020.
A month ago, at the 20-year auction on August 19, the bond had sold at a yield of 5.204%. At the auction in July, it took 5.163% to sell those bonds.
Today’s auction yield finally broke the record set at the auction in October 2023, so three years ago just before the peak of the prior yield spike when the 10-year yield broke through 5% briefly. At that auction, the 20-year bond had sold at a yield of 5.245%, after which the 20-year yield plunged in the secondary market by about 130 basis points in 11 months.
The 2.0 basis-point tail: not the worst ever, but substantial. When a bond auction is announced, the new “when-issued” bond starts trading before the actual auction and before it is actually available for sale. The when-issued trading allows for some price discovery in the market before the auction.
This 20-year when-issued bond traded at a yield of 5.40%. But then at the auction, the yield was 5.42%, so 2.0 basis points higher than the when-issued yield. This 2.0 basis point “tail” indicates that demand at the auction was substantially weaker than the market had expected. Since the 20-year auctions were re-introduced in March 2020, they experienced bigger tails, including over 3 basis points, but 2.0 basis points is substantial.
The Bid-to-Cover Ratio was a middling 2.57, with $33.38 billion in bids and $13.00 billion accepted. It was better than a month ago (2.53), but below the the July auction (2.64).
Indirect Bidders purchased 52.5% ($6.78 billion) of the total, which was the lowest so far in the six-year existence of the modern 20-year bond auction.
These are buyers that placed a competitive bid through a primary dealer or direct submitter, and include foreign central banks that bid at the auction through the NY Fed. While the auction results lump foreign bidders together with other indirect bidders, the low ratio suggest that there was severely lacking enthusiasm among foreign buyers for the 20-year bond.
The function of yield is to create demand, so the yield rises until there is enough demand, which is what an auction accomplishes. There will always be demand, but the yield has to be high enough, and for the government it may be shockingly high, which would be appropriate given its shockingly high fiscal deficits and its shocking inaction about the shockingly high deficits. And the whole thing is topped off by inflation that has been high for a shocking five years.
At some point, investors find the yield attractive and buy. But at some point, the yield may be too high for the government… And that would be a good opportunity for Congress to sit up straight and pay attention and get its fiscal mess in order. But we’re not there yet.
In the secondary market, the 20-year bond yield rose to 5.44% this morning before easing a bit and currently is at 5.41%, all the highest since 2007, and roughly 4 basis points higher than the 30-year yield (5.37% currently).
The 20-year maturity is the unloved newcomer. It generally sells at auction at a higher yield than 30-year bonds. The difference in 2020 was as high as 20 basis points but has narrowed since then to just a few basis points. There is only a relatively small number of 20-year bonds out there; the auctions are small; and liquidity for the 20-year maturities is low. They also feature high on the Treasury buyback list, in part to provide some liquidity in this low-liquidity corner of the market.
The 10-year yield (5.0%) and the 30-year yield (5.37%) are also the highest since 2007.
That year 2007 was the last year before the Fed’s QE and interest rate repression killed the bond market. The Fed eased out of that monetary experiment starting in 2022, amid the worst inflation in 40 years, and the bond market has slowly come back to life. These 5%-plus yields were considered normal to low in the decades before 2007.
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When are the credit spreads going to widen?
Wolf, do you (or anyone) have a sense for what fractions of foreign Treasury holdings are currently held in the different bills, notes, and bonds? Historical figures for the past 10 years or so? And their approximate maturity dates? I understand that’s an incredibly complex picture which requires a TON of data, some of which may not be public.
The reason I ask is because with the 2.0 basis point tail on the 20-yr bond auction yield, it seems as you suggest that demand is on the lighter side. As the bills/notes/bonds mature, particularly for foreign holders, they may decline to purchase long-term Treasury debt, and instead opt for short-term bills. Or something else entirely. This wouldn’t bode well for the Treasury as it would be less demand for long-term bond issuance, which would drive up yields all else being equal.
Personally, I think that would bode well for getting Congress to act.
I’ve really enjoyed your more frequent articles on everything bond market related, too. Thank you.
“I’ve really enjoyed your more frequent articles on everything bond market related, too.”
Not to go all “timing the market” but maybe Wolf is feeling like things are coming to a head. We sure seem to have painted ourselves into a corner from my ignorant point of view. Not to put words in Mr. Wolf’s mouth of course.
I wonder if the bond market will scoff at tomorrows likely piddly .25% raise and keep turning the screws. Things will get ugly if they hold or worse yet, Trump gets his way and cuts come to pass in the near future.
One element of perspective — consider this from WR’s analysis today:
“That year 2007 was the last year before the Fed’s QE and interest rate repression killed the bond market.” Now, what happened in 2008 that launched the period of “interest rate repression?” Well, a financial crisis and Great Recession that could have become a 2nd Great Depression absent that repression, that’s what. Of course, avoiding a global depression by that policy choice came with lasting and severe side effects on real estate prices and other asset prices and many other dislocations and distortions. Free money isn’t free. But we avoided a 2nd Great Depression, and that’s something.
Maybe since 2007 the Fed has erred by leaning its policy too much toward the full employment part of its dual mandate, and too little toward the anti-inflation part. But it is a dual mandate, and we shouldn’t forget the context that led to the long period of interest rate repression. I don’t think the U.S. or the world economy came out the financial crisis and Great Recession as badly as could have been, and that the Fed’s semi-success at least avoiding a deflationary depression should be reckoned into the context when judging the interest rate repression era.
That said, I’m pleased that the bond market is working again. I’m a saver, not an investor, and the higher yields now available for risk averse savers are a small comfort in truly weird times.