[NEW JERSEY] Global investor pushback against long-term government debt is turning what normally would be a routine US bond auction into one of the most anticipated events on Wall Street this week.
The Treasury is set to sell US$22 billion of 30-year government bonds on Thursday (Jun 12), part of its regularly scheduled borrowings. The results, though, will receive special attention because they will offer an instant readout on the scope of market demand at a time when investor appetite for 30-year US debt has soured.
“All the auctions will be viewed through the lens of a test of market sentiment,” said Jack McIntyre, portfolio manager at Brandywine Global Investment Management. “It feels like US Treasury 30 years are the most unloved bonds out there.”
Yields on long-term global debt have soared in recent weeks as concern over spiraling debt and deficits led some investors to shun the securities and prompted others to demand a higher premium for the risk of lending to governments.
US 30-year yields touched a near two-decade high of 5.15 per cent last month, and even at 4.94 per cent as of Friday were still more than a half-point above levels seen as recently as March.
Higher yields mean funding pressure at a time when the US is borrowing more and government spending remains rampant. The House-passed version of US President Donald Trump’s tax-and-spending bill is forecast by some to add trillions to US budget deficits in the years ahead. Moody’s Ratings lowered its credit score on the US last month.
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“We are in a disturbing fiscal trend,” said Fred Hoffman, a former fund manager who turned to academia about seven years ago and is now a professor of finance at Rutgers Business School.
Hoffman said he will monitor the results of the auction next week while he’s at his vacation home in Martha’s Vineyard. Details such as the auction “tail” – where yields settle versus the when-issued level – and the extent to which orders exceed the amount of debt for sale will provide clues about demand. Foreign participation will also be in the spotlight.
“If this auction and the next auctions continue to break down with lousy tails and horrible bid-to-cover ratios, then we have problem,” said Hoffman, who discusses debt markets and mechanics in some of his class lectures.
Lackluster demand for a May 21 auction of 20-year bonds – not an investor favorite – was enough to send yields surging that day. A similar performance for the 30-year bond, a global benchmark, would be even more worrisome.
The Treasury will also auction US$58 billion of three-year notes on Tuesday and US$39 billion of 10-year debt on Wednesday.
To be clear, no one is raising the possibility of a so-called failed auction, and there are backstops embedded in the process to help avoid major dislocations. A network of two dozen primary dealers is required to bid at all auctions.
The recent rise in yields may also draw in buyers. Brandywine’s McIntyre said he recently bought 30-year bonds at a yield of around 5 per cent, a level some see as attractive.
‘Becoming disconnected’
For many, though, the bigger picture is one of elevated long-term yields for the foreseeable future, even if the outlook for shorter-term securities improves once the Federal Reserve moves closer to cutting interest rates.
Greg Peters, co-chief investment officer at PGIM Fixed Income says it’s just safer to avoid long-dated Treasuries given they are increasingly linked to political forces rather than monetary policy.
“Look at what’s happening in the long-end rates market: It’s becoming disconnected,” said Peters, who helps oversee US$862 billion of assets, on Friday. “It’s being driven by risk premium, politics, all these other factors.”
A reading on Friday of US employment in May beat forecasts, prompting a rise in yields.
Still, swaps traders are pricing in expectations that the Fed will cut rates by about a half a percentage point in the second half of the year. Fed rate reduction wagers have waxed and waned since December, with the prospect that the Trump administration’s tariffs agenda will reignite inflation serving as the primary catalyst for when traders have adjusted wagers.
All of this has triggered a so-called steepening of the yield curve and surge in the compensation investors demand – known as term premium – to lend money to the government for decades.
A widely-followed New York Fed measure of 10-year term premium is now at almost three-quarters of a percentage point, after being negative about a year ago. That’s helped the yield curve steepen, as measured by the gap between rates on US five- and 30-year debt.
Also in the mix is a controversial piece of the Trump-backed tax bill. The “revenge tax” provision, which would hit foreign investors in the US with a surcharge if they are domiciled in countries with “unfair” tax regimes, has stirred concern of a buyers’ strike on US debt. House Ways and Means Committee spokesperson JP Freire has said the retaliatory tax would not cover portfolio interest such as on Treasuries, though questions remain.
Data on the docket this week includes measures on the pace of price gains in May, including both consumer and producer prices, as well as a gauges of inflation expectations – all of which could spark movements in the curve.
“Overall, a steeper yield curve is the most likely outcome going forward,” said Kathy Jones, chief fixed income strategist at Charles Schwab. “If we get soft enough data and the Fed cuts, then it’s going to pull short-term yields down. But I think the long end will still be plagued with the issues around the deficit and the long term outlook for a weak dollar and regarding capital inflows.” BLOOMBERG
