People Are Buying US Treasurys

In a telling sign of just how hyper-focused people are on bond markets right now, one of this week’s most-watched events was  … Treasury bond auctions. Usually, the Treasury’s debt sales to its regular customer base of banks and institutional investors don’t garner much attention. Success is usually a foregone conclusion, making them more dog bites man than man bites dog for news editors. But two weeks ago, a sale of 7-year Treasurys attracted the lowest demand since 2009. (Never mind that bids totaled just over twice the amount on offer.) That supposedly bad auction triggered some fear, contributing to yields’ recent uptick, and making this week’s three auctions much-watched events. The last one happened today and—spoiler alert—it went great, which we think offers a couple of lessons for investors.

The first of this week’s festivities was an auction of 3-year notes on Tuesday, which attracted demand of 2.69 times the amount on offer at a median yield of 0.32%.^[i] Wednesday’s offer was a 10-year note, which was similarly oversubscribed with a bid-to-cover ratio of 2.38 at a median yield of 1.47%.^[ii] Rounding out the pack was Thursday’s sale of less-plentiful 30-year bonds, which attracted bids for 2.28 times the amount on offer an a median yield of 2.23%.^[iii] All were nicely above the 2.04 bid-to-cover ratio at that supposedly disastrous 7-year auction two weeks ago.^[iv] They were also right in line with their trends over the past eight months since yields bottomed last August. That suggests to us that the panic-inducing auction was an aberration and investors are very, very happy to buy US bonds.

The surface-level takeaway here is that Congress’s multiple debt-financed COVID relief bills aren’t denting demand or visibly inducing concerns about Uncle Sam’s creditworthiness. Even with the recent uptick, yields remain near generational lows, keeping that new debt affordable. Think through that 30-year auction—the Treasury will be paying 2.23% on that tranche of debt until 2051. That is a wonderfully long time to lock in low funding costs.

The potentially more interesting aspect to all of this is the timing. The other big interest rate-related item preoccupying investors these days is the pending implementation of a bank capital rule called the Supplementary Leverage Ratio (SLR). (Yes, we know bank regulations are boring, but stay with us.) That rule mandates that banks hold a given amount of capital relative to their entire book of assets, without any consideration for how risky those assets are. So a stake in Bitcoin would require as much backing capital as an equivalent US Treasury holding. This was supposed to take effect last March 31, but when markets were going haywire during the pandemic panic, the Fed gave banks a one-year grace period. Now the new deadline is looming. Some argue this will trigger a rush of bond sales as banks race to get their books in compliance—and reduce demand for Treasurys overall.

This week’s auctions imply that isn’t the case. It seems fair to assume that banks didn’t load up on shiny new Treasurys today only to sell them next week. That just isn’t how these things work. So either banks bought bonds because they are in good SLR shape, or demand is a lot more broad than that—or, more likely, both. Either way, considering research we have seen suggests only two large-ish US banks aren’t already in compliance with SLR rules, we think this issue is rather overstated.

We will end with a broad conceptual point: These auctions show markets are working largely as they are supposed to. The thesis that higher rates would deter buyers and become a self-fulfilling prophecy has long run hollow with us, because prices are a signal. When yields tick up, it gives investors a chance to buy one of the world’s most sought-after assets at a small discount and get a modestly higher return. That is an incentive! Better prices attract buyers to the marketplace. As this happens, it wouldn’t surprise us if investors bid prices back up over the period ahead, putting a lid on yields. As we wrote earlier this week, that is an outcome few seem to expect right now, judging by the record amount of short interest in Treasury bonds. When a trade is this crowded, markets usually do something different than most expect, and it wouldn’t shock us at all if these over-watched auctions that went way better-than-feared were a sign of that starting to happen.