Monday 12/11/23
WSJ Today Page B1
The U.S. Treasury prefers its debt sales to be humdrum affairs. Lately, they are sparking fireworks in markets.
Scrutiny of Treasury auctions—whereby the government funds operations by selling the world’s safest bonds to big banks and dealers—has grown alongside their size. For years, many in Washington and on Wall Street assumed that investors would buy any number of bonds the government issued, no matter the fiscal outlook. Testing that assumption: the sale of $20.8 trillion of new Treasurys in the first 11 months of the year—set to surpass 2020’s record of just under $21 trillion.
Whether the market can absorb the rolling waves of debt without disruption is the biggest question on Wall Street ahead of this week’s planned Treasury auctions. A combined $108 billion of 3-year, 10-year and 30-year bonds hit the block Monday and Tuesday, along with $213 billion of shorter-term bills. The last 30-year auction was so poorly received that it rattled other parts of the markets. Investors fear that signs of weak demand might spread similar tumult, raise the cost of government borrowing and hurt the economy.
Here’s what to know:
How Treasurys are sold
The Treasury Department auctions off bonds in chunks by maturity at monthly intervals. Everyone from individuals to foreign banks can buy them in exchange for reliable coupon payments and the government’s guarantee that they’ll get their money back when the bond matures.
The government announces its borrowing plans each quarter, but waits to schedule individual auctions until a few days ahead. Among the main participants are so-called primary dealers—banks that can trade with the Fed. They are required to bid at auctions and often end up buying more bonds when demand is weak.
Wall Street covets brand-new bonds because they are the easiest to trade. Rates are determined at auction. Advanced trading by the primary dealers helps set expectations for the new bonds’ yield—or the average annual return investors will receive until maturity, based on the bonds’ price and coupon. So-called when-issued trading accounts for more than 10% of all Treasury transactions, according to New York Fed research.
All prospective buyers then place competitive bids, telling the government the payout they want to receive. The Treasury first accepts the bids with the lowest yield (which would cost the government the least), then the next-lowest, scaling the ladder toward its borrowing goal. The highest rate needed to complete the auction—the so-called high yield—is what all bidders receive.
An auction is considered weak when the government ends up having to offer investors much higher yields than the market expected, or when primary dealers have to buy a lot. If yields come in below expectations, Wall Street is encouraged by the strong demand.
Individuals at home can also buy Treasurys at auction by making an account at the TreasuryDirect website.
Why investors are on edge
Wall Street has its own lingo to describe how an auction went. When the yield is higher than expected? Investors call that a “tail.” When it’s lower, that is a “stop-through.” Auctions that meet expectations are said to be “on the screws.”
Last month’s 30-year auction had a massive tail by historical standards. Primary dealers bought nearly a quarter of the issuance, more than double their average. The previous 30-year auction also didn’t go well.
Few fear an outright auction failure. That is an unlikely scenario that analysts said could potentially kick off prolonged and catastrophic market turmoil.
Gauging demand
Investors gauge demand at an auction by looking at the “bid-to-cover” ratio. That measures the size of buyers’ orders—or bids—against how much money the Treasury is looking to raise. The higher the ratio, the better. There are always enough buyers; the worry is that they’ll demand elevated payouts.
(All Treasury securities are generally known as bonds. But to traders, “bonds” are debt instruments with maturities longer than 10 years; “notes” are those that mature in two to 10 years; and “bills” have maturities of a year or less. To make it even more complicated, bills don’t pay coupons—investors buy them at a discount and redeem them at par. So everything maturing in more than a year is often known as a “coupon.”)
Enthusiasm for longer-term bonds has waned. After long-term yields rose to 5%, the Treasury Department decided to sell fewer than analysts expected. Instead, it chose to continue pumping out Treasury bills at a pace typically associated with recessions or extraordinary borrowing needs: more than half of all issuance. T-bills are much less volatile because they come due so quickly.
The government has been advised to maintain T-bills at around 15% to 20% of the overall debt load. As of the end of November, bills make up 21.6% of the $26.3 trillion of U.S. debt.
Many analysts expected a return to typical bill issuance levels this year. The Treasury Department issued $824 billion of T-bills from July to September, the majority of its $1.01 trillion borrowing spree. Much of that issuance was used to quickly refill the government’s coffers after Congress finally raised the debt ceiling.
Now the Treasury Borrowing Advisory Committee suggests that the government be mindful that demand for its debt is waning and consider exploring “if more meaningful deviations are necessary.”
How Wall Street reacted
Investors were so encouraged by the borrowing plans that they scooped up stocks and bonds, propelling markets higher. The stock market prefers this approach right now because prices of longer-term bonds are more sensitive to changes in interest rates.
“We’re getting lower bond issuance than we expected, meaning there’s pressure off bonds in the near term,” said Andy Constan, chief executive of Damped Spring Advisors, a consulting firm for macro hedge funds. “But the federal deficit isn’t going away. Quantitative tightening isn’t going away. Those are things which need to be financed—which requires bonds.”
“The longer they wait, the bigger the issue becomes,” he said.
That leaves the Treasury at a crossroads. It can issue more long-term debt and lock in high borrowing costs for years. Or it can stick with short-term Treasury bills and promote risk-taking on Wall Street. For now, it is opting for the latter.
Why people are still worried
Wall Street has a limited capacity for how much risk it can take. Bonds sap some of that risk budget. But because T-bills are effectively treated like cash, absorbing bills rather than bonds gives investors more room to buy riskier assets such as stocks.
Many worry the flood of long-term bonds is outstripping demand for them. Bond yields surged this summer after the Treasury surprised Wall Street by announcing it would borrow roughly $1 trillion in the year’s third quarter, more than a quarter trillion dollars above previous expectations.
Some analysts say that the Treasury’s new plan just kicks the can down the road, exchanging calm today for the risk of resurging inflation and market pain later.
“Increasing bill issuance effectively stimulates the economy by pumping markets higher,” said Stephen Miran, co-founder of asset manager Amberwave Partners and a former senior adviser to the U.S. Treasury, where he assisted with the Covid-19 response. “The inflation genie is out of the bottle, and stoking easier financial conditions isn’t going to help put it back in.”
Many of the investors who were betting bond yields would go higher as prices fell were forced to quickly exit those trades as yields sank, according to Miran. He said that reversal has helped bond prices rally alongside encouraging inflation prints showing that price pressures are subsiding.
But fundamental problems remain.
The decision to sell more bills and less long-term debt comes at an unusual time, while the Fed is paring its bondholdings through its quantitative tightening program. The central bank is seeking to tighten financial conditions and limit other risks that Wall Street can take. By reducing the supply of bonds and notes relative to bills, the Treasury is, in essence, complicating the Fed’s inflation fight and precipitating more speculative bets.
Professor Elam 