Is the US Treasury market threading a dangerous zone?

Spread the love

The two-year auction saw a relatively weaker demand that could signal a drop in appetite by investors for Treasuries. Indeed, the bond market volatility has been a critical concern given the background issues of a large federal deficit and uncertainty on the path of interest rates.

Tuesday Auction

During the afternoon, the US Treasury Department started an auction for its two-year notes worth $51 billion. The outcome is a clearance rate of 5.055%, the highest acceptance rate. This is in line with the yield expectation. However, if we are to zoom into two key metrics, it sheds light on a different story.

#1: A weaker bid-to-cover ratio

What does this term mean? Essentially, the total amount of dollars bids are received during this Treasury auction compared to the actual amount sold. So, this ratio allows us to understand the demand and “enthusiasm” for the treasury.

Tuesday’s auction came in at 2.64 times, much lower than the 2.73 times we saw in September, where a similar 2-year auction was issued. Going back to August, the figure was 2.94 times. If we look at the average figure for the past six auctions, the ratio is 2.83.

Therefore, the drop in the bid-to-cover ratio shows a cooling demand for such securities.

#2: Primary dealers acceptance rate

Typically, in Treasury auctions, the primary dealers will have to scoop up any supplies that bidders do not take up. The figure is 17.6%, the highest level since April.

General concern on US economic path and debt sustainability

There are genuine concerns about the US government’s ability to finance its ballooning federal deficit over the longer term. Moreover, the malfunction of the House without a Republican leader adds complication to the ability of the government to pass important bills.

For fiscal 2023, the US deficit hit a high of $1.7 trillion, a jump from $1.4 trillion in 2022 based on data released by the Congressional Budget Office that released the data on October 10. With higher spending likely, we can expect more issuance of government debt. Based on some research, the debt issuance in the Treasury market till September 2023 is 26% higher than the comparable period a year ago.

As most analysts would point out, this pushes Treasury bond yield higher. Indeed, a flood of new bonds could result in investors demanding higher yields, causing bond prices to fall. Bond prices and yields have an inverse relationship.

Uncertain interest rate path hit demand nerve.

Investors dancing away from Treasuries could also be attributed to the higher probability that the Federal Reserve may further raise rates in the future, causing a further drop in bond prices and pushing yield higher. If that is the case, one may tend to wait for yield to go up further, thus causing tepid demand for recent treasury auctions.

While things appear calm now, we can’t help but keep our eyes on the Treasury market for any further volatility that could hit the market.