The bond market is coming out from under 14 years of interest rate repression and is doing its thing, the way it is supposed to. And that’s what Warsh wants it to do.

By Wolf Richter for WOLF STREET.

At the 10-year Treasury note auction today, it took a yield of 5.30% to round up enough demand to sell all of the $39 billion of notes. Creating demand is what yield does, that’s its job. And it did.

That was the highest auction yield since November 2000, when yields were coming down because the Dotcom Bubble was imploding by that time, dragging down the economy that would skitter into a recession by March 2001. In 2000, there were four 10-year note auctions; the last two had yields in the 5.8% range, the first two in the 6.5% range.

A month ago, at the 10-year note auction on September 9, it took a yield of 4.834% to sell all $39 billion of 10-year notes. Two months ago, it took 4.683%. Three months ago, it took 4.58%.

Higher yields today mean lower prices for existing bond holders who bought at those prior auctions, or bought anywhere, at lower yields. That’s the bond bloodbath of rising yields: they’re appealing to buyers but crush existing holders.

The 1.7 basis point negative tail. The new “when-issued” note started trading after the note auction was announced, and continued trading until the auction closed at 1 PM. The when-issued trading allows for some price discovery in the market before the auction. When-issued trading ended at a yield of 5.317%.

But at the auction, the yield stopped out at 5.30%, a lower yield than the when-issued yield, so a negative tail of 1.7 basis points. This stop-through, the biggest since April last year, indicates that there was more demand for the notes than traders in the when-issued market had feared.

In the secondary market, the stop-through was a relief.

The Bid-to-Cover Ratio was 2.77, not exceptional, but better than a month ago (2.71), and above the six-month average (2.54), with $108.07 billion in bids and $39.00 billion accepted. This was also a relief for the secondary market.

Indirect Bidders purchased 80.3% ($31.1 billion) of the total, above the six-month average of 74%.

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 high ratio suggest that there was substantial interest among foreign buyers for the 10-year notes at that yield.

That was also a relief for the market that feared that foreign investors would turn their backs on US debt.

It was a “reopening” auction, the second “reopening” auction of the notes that had originally been sold at the auction in August, with the same CUSIP number, the same coupon interest rate (4.625%), and the same maturity date (August 15, 2036). So the notes sold today mature in 9 years and 10 months on August 15, 2026.

The difference was the price established at the auction. Today’s auction price was 94.86 cents on the dollar. The lower price with the same coupon interest produced the yield to maturity of 5.30%.

At the original sale of this 10-year note issue on August 12, the auction price was 99.54 cents on the dollar, for a yield of 4.683%.

The long-used practice of selling the same issue over three auctions, therefore selling only four 10-year note issues per year, the Treasury Department puts three times as many of the same notes with the same CUSIP number on the market, which provides better liquidity for trading later.

Yield creates demand but is not free for the debtor. Yield rises until there is enough demand to sell the whole batch, which is what a Treasury auction accomplishes. There will always be demand, but the yield has to be high enough, and could get shockingly high, which might be what it would take to get Congress and the White House to pay attention and deal with the deficit.

But not yet. A 5.30% 10-year yield at the current rates of inflation and the fiscal nightmare Congress and the White House keep concocting is still on the low side. What’s shockingly high is the deficit.

The secondary market breathed a sigh of relief. The 10-year yield had risen this morning as high as 5.36%, on expectations of an ugly 10-year auction, but then eased to 5.32% just before the auction, in line with when-issued trading, and then after the auction, the yield eased further to 5.28% at the moment.

What this long-term chart of the 10-year Treasury yield shows is that the bond market, starting in 2022 amid the worst inflation in 40 years, has been coming out from under 14 years of interest rate repression by the Fed, and is now on its own and doing its thing the way it is supposed to. And that’s what Warsh wants it to do.

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