Investor demand for US bonds weakens, indicating concerns about America’s fiscal health.
Financial Markets Signal Weakening Demand for US Government Bonds
It seems that financial markets are sending a message: demand for US government bonds may be starting to weaken. This comes after disappointing results from a recent Treasury auction.
The United States recently sold $20 billion of 30-year bonds at an Oct. 12 Treasury auction. Primary dealers, who are required to participate in these auctions and purchase any remaining supply, bought over 18 percent of the bonds. This is higher than the average of nearly 11 percent seen this year.
During the auction, investors remained on the sidelines, resulting in a higher-than-expected yield for the long-term Treasury security. The accepted yield for the 30-year bond was 4.837 percent, about 4 basis points higher than the projected yield.
Some market observers believe that the lackluster demand for the 30-year bond may not accurately reflect investor sentiment. However, weaker demand has also been seen in recent auctions for 3-year and 10-year Treasurys.
During an Oct. 10 auction, dealers purchased 22 percent of the $46 billion supply of 3-year bonds. At an Oct. 11 event, dealers acquired 19 percent of the $35 billion supply of 10-year Treasury securities.
Experts in the industry warn that this is a clear sign that the volatility in the bond market is far from over and could continue. Yields for the 2-year, 10-year, and 30-year bonds reached their highest levels in 16 years as investors fear that the Federal Reserve will continue raising interest rates due to inflation and strong labor market data.
According to the Summary of Economic Projections, the Federal Reserve plans to raise the median policy rate to 5.6 percent with one more hike. The central bank has kept the target Fed funds rate between 5.25 percent and 5.5 percent. Additionally, policymakers have reduced their expectations for rate cuts next year by 50 basis points.
Meanwhile, some regional Fed bank presidents believe that the recent increase in Treasury yields could assist in the tightening efforts, potentially eliminating the need for further rate hikes by the Federal Open Market Committee.
State of Treasury Securities
Over the past year, there has been a debate about the liquidity in the bond market due to the Federal Reserve’s quantitative tightening campaign since March 2022.
In October 2022, Treasury Secretary Janet Yellen expressed concerns about the market’s liquidity amid rising costs. However, she remained confident that the market was functioning well and that her department would take steps to improve the Treasury market.
One of the main challenges is the oversupply of bonds by the US government. After depleting the Treasury General Account during the government default earlier this year, the department has flooded the capital markets with Treasurys. In the third quarter alone, over $1 trillion in bonds were issued, with plans to sell another $850 billion in the fourth quarter.
In addition to replenishing its bank account at the Federal Reserve, the US government is seeking more cash to fund its growing national debt and budget deficit. However, if investor demand continues to decline in 2024, it could indicate concerns about the government’s fiscal condition.
In August, Fitch Ratings downgraded the US credit rating to AA+ due to expected fiscal deterioration, high government debt, and governance issues. The agency highlighted the significant increase in interest service burden as one of the fiscal challenges.
The national debt has surpassed $33.5 trillion, and the federal deficit is nearing $2 trillion for the current fiscal year. Interest payments alone will reach approximately $1 trillion this year.
Another factor affecting demand is the need for the US to compete with other countries as central banks raise rates in response to inflation. If other markets offer higher yields, the US may need to provide better returns to attract investors.
For example, the UK’s 10-year bond recently reached a 15-year high of around 4.5 percent, and the Bank of Japan has indicated it will allow the yield on its 10-year bond to rise further.
Some speculate that the Federal Reserve may intervene and buy government bonds, but this would contradict their efforts to reduce their balance sheet, which is still significantly larger than pre-pandemic levels.
As of the week ending Oct. 12, the Fed held close to $5 trillion in Treasury securities, according to the H.4.1 data.
Good News and Bad News
There is some good news and bad news in this situation. Experts, including Goldman Sachs Research’s Chief Interest Rates Strategist Praveen Korapaty, predict a rally in the bond market to end the year and start 2024.
However, the recent events in the Treasury market serve as a cautionary tale about the country’s fiscal health.
The benchmark 10-year yield closed at around 4.74 percent on Oct. 16. The 2-year yield surpassed 5.1 percent, and the 30-year bond approached 4.89 percent.
What does the recent Treasury auction results suggest about the demand for US government bonds?
“Financial Markets Signal Weakening Demand for US Government Bonds”
It appears that the financial markets are sending a concerning signal, indicating a potential weakening in demand for US government bonds. This conclusion is drawn following disappointing results from a recent Treasury auction.
At an October 12 Treasury auction, the United States sold $20 billion worth of 30-year bonds. Primary dealers, who are obligated to participate in these auctions and purchase any remaining supply, bought over 18 percent of the bonds, surpassing this year’s average of nearly 11 percent.
However, during the auction, investors remained on the sidelines, resulting in a higher-than-expected yield for the long-term Treasury security. The accepted yield for the 30-year bond was 4.837 percent, approximately 4 basis points higher than the projected yield.
Some market observers argue that the lack
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