Liz Looks at: Treasury Auctions

By: Liz Young Thomas · November 30, 2023 · Reading Time: 5 minutes

Going Once, Going Twice

At first glance, the topic of this week’s blog may sound dry and like something that’s only interesting to economists or professors. But Treasury auctions have turned into quite a hot topic lately.

But why? And why do they matter to investors?

For starters, the sizes of these auctions are rather large, particularly for a period of time when we’re not in a crisis. Additionally, the appetite for newly issued Treasuries has been waning due to a few large buyers exiting the scene (more on that in a minute). That’s showing up in the auction results, and sending tremors across bond and equity markets.

An important layer to the story is the rise in interest rates over the last 12-18 months. As rates rise, so do Treasury yields and coupons on newly issued debts, which increases the expense burden on the federal government (more on that in a minute, too), and our budget shortfall persists.

To be clear, nothing bad has happened yet. And there is a school of thought that nothing ever will, because so far, although the auctions have been met with weaker demand, they’re still getting done. And the U.S. is still the most credit-worthy country in the world, so a default or material deterioration seems highly unlikely, not to mention politically unsavory.

Buyers be Bygones

For a long time, there were three big buyers of US Treasurys: the Federal Reserve, Japan, and China. But all three of these big buyers have reduced their purchases, if not turned into net sellers of Treasuries.

We’ll focus mainly on the Fed in this piece since monetary policy is front and center. A big reason for the Fed turning into a net seller of Treasurys was its quantitative tightening program — intended to reduce the size of the Fed’s balance sheet and fight inflation — that began in mid-2022.

This shift had been well-telegraphed, and ended up being part of the catalyst that drove Treasury yields higher into the summer of 2022, with the 10-year yield rising to 3.47% (which, believe it or not, was eye-popping at the time). Little did we know, our eyes would completely burst the following October when it hit nearly 5.0%, but I digress.

The problem with the Fed not acting as a net buyer anymore is that as big buyers stopped buying, the amount of debt we needed to issue started rising.

The chart above shows the trend of treasury issuance, divided into T-bills (maturities of one year or less), and T-notes and bonds (2 to 30-year maturities). We can see the rise in issuance in late 2020 to cover Covid-related fiscal stimulus.

Notice the rise in issuance in 2023, absent a crisis-related stimulus package. Not to mention the two times this year alone that we’ve worried about a government shutdown due to not being able to cover our obligations. Credit-worthy or not, the increasing amount of debt that needs to be absorbed without the usual suspects there to absorb it is more than mildly concerning.

Hot Potato Bonds

As with most things government-related, the way auctions function is not straightforward. Although it’s concerning that big buyers have reduced their buying appetite, there is a back-up plan called primary dealers . The plan is basically that whatever isn’t bought by other bidders in a Treasury auction, has to be absorbed by primary dealers.

That’s all well and good because they’re used to acting as the backup plan, and they’re active in every Treasury auction that takes place. The interesting part about the recent activity is that because there has been less demand from other buyers, the primary dealers have had to absorb an increasing amount of issuance.

It’s almost as if these auctions are becoming a game of hot potato.

Up, Up, and Away

As with any bond, if buying appetite is low, yields tend to move higher. But this is a period of falling inflation, rate cuts being priced in, and an equity rally driven largely by the swift drop in Treasury yields since mid-October.

If these auctions continue to get weaker and weaker, they could serve as a catalyst for yields to rise again — creating a less friendly environment for stocks. Plus, much like the concept explained in the beginning of this piece, if yields go higher, so does the U.S. interest expense. And according to the Congressional Budget Office, net interest expense as a % of GDP is already projected to grow rapidly over the next few decades.

Needless to say, this topic has become one to pay attention to even if it feels far-removed from your financial life. It’s turned into a market mover, and one that isn’t sending signals of stability.


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