Treasury Market Stress: Primary Dealers Taking Up Slack As Foreign Demand Fades

Treasury auctions are coming under scrutiny for the latest signs of stress in the government bond market.

What Happened: The U.S. looks to raise higher levels of capital in fixed-income markets next year.

Yields spiked to 16-year highs in October as higher interest rates and the absence of some foreign buyers meant that primary dealers demanded lower prices — yields on bonds rise as prices fall — to fully cover Treasury auctions.

During one auction of $20 billion of 30-year notes in November primary dealers had to take up 18% of the supply. Typically, they would account for around 11% of sales.

This Week’s Auctions: On Monday, the Treasury auctioned $50 billion in three-year notes and $37 billion in 10-year notes. Primary dealers bought upwards of 17% of the supply.

It was probably of little consequence. The bid-to-cover ratios — a measure of demand — were good: at 2.54 on the 10-year bond, demand was solid and above November’s 2.45. A bid-to-cover ratio of above 2.4 is generally seen as good, and the yields shouldn’t move much. Below 2.2 signifies weak demand and yields are likely to be pushed higher.

Also Read: Foreign Buyers Desert US Treasury Bond Market As Supply Increases

However, the yield demanded by investors at the 10-year bond auction at 4.296%, was a little higher than expected, but below recent highs. On the secondary market, the yield rose to 4.291% before trading on Tuesday at 4.237%.

On Tuesday, the results of an auction of 30-year bonds are due after the market close. Last month’s auction on Nov. 9 resulted in a yield of 4.77% being demanded by traders.

Why It Matters: Yields have come off the highs seen in October pushing prices back up. Treasury-backed exchange-traded funds have also traded higher since then — with the iShares 20+ Year Treasury Bond ETF TLT gaining 12% since Oct. 23.

The supply-demand environment will become ever more pertinent in 2024. The government is expected to issue a record amount of debt over the year.

As well as the government’s funding requirements, it is looking to ease its budget deficit after overspending by around $1.7 trillion in 2023. On top of this, around a third of existing US government debt reaches maturity — valued at around $7.6 trillion.

Impossible numbers: To cover its 2024 budget, service its deficit and redeem matured bonds, it would likely cost close to $10 trillion.

According to asset management firm Apollo, average bond auction sizes will have to be 23% higher next year than in 2023 to accommodate the extra issuance — this will “stress-test demand for Treasuries,” said chief economist Torsten Sløk.

And not only is there more issuance but, as suggested by the higher auction subscriptions of primary dealers, there are fewer buyers. Benzinga reported in November that foreign buyers had cut down their exposure to Treasuries.

“The buyer of Treasuries at this point is domestic asset managers, as overseas investors have better alternatives at home. In the future, the most likely source of Treasury demand will be the Fed,” said Mark Cabana rates strategist at Bank of America.

Now Read: Don’t Get Caught In Equity Rally Hype: Lessons From 2023 To Remember In 2024

Image: Shutterstock