ROI - For the Trump-led Treasury, the "tail" of the auction is the most difficult part: McKeever

The views expressed in this article are those of the author alone, who is a Reuters columnist.

Jamie McGeever

Reuters Orlando, FL, October 6 - U.S. Treasury auctions are supposed to be dull, predictable, and generally not newsworthy. But these are not normal times, and the Trump administration now faces the risk that weak government bond sales could become front-page news.

The U.S. Treasury plans to issue nearly $120 billion worth of government bonds this week, marking the first auctions in two weeks outside of short-term Treasury bills: $58 billion in three-year notes on Tuesday, $39 billion in ten-year notes on Wednesday, and $22 billion in thirty-year bonds on Thursday.

These auctions would typically be insignificant under normal circumstances, but due to the exceptionally weak auction results between September 22 and 24—especially the five-year note auction on September 23—they are receiving increasing attention. That particular auction triggered the biggest surge in bond yields since April of last year. Since then, yields have not only failed to retreat but have instead soared to multi-decade highs across most maturities.

It is worth noting that the likelihood of a "failed" U.S. Treasury auction is virtually zero. Primary dealers—currently the 26 Wall Street banks and institutions authorized by the New York Fed—serve as market makers in the government bond market and will always participate. They essentially underwrite the sales, ensuring the smooth operation of the $30 trillion U.S. Treasury market—the world’s most liquid market.

This, in turn, keeps the entire global financial system functioning. Trillions of dollars in global debt, assets, and market derivatives are benchmarked against U.S. Treasuries. U.S. government bonds also serve as the collateral that "lubricates the pipes" of both the U.S. and global financial system—including repo agreements, interbank lending, and financing.

In short, as long as U.S. government bonds remain the linchpin of the global financial system, there will always be buyers at Treasury auctions. The perpetual question is at what price these bonds will eventually be sold. Currently, borrowing costs in the secondary market are at their highest levels since the mid-2000s, so it stands to reason that the Treasury will also have to pay higher rates in the primary market.

But as recent auctions have shown, there is always the possibility of unfavorable surprises.

“Too big for the market to absorb”?

The $70 billion five-year note auction on September 23 was one of the most concerning in recent years. Demand—as measured by the "bid-to-cover" ratio—was the lowest in nine years. The Treasury ultimately sold these bonds at a yield of 5.033%, more than three basis points above the market yield at the close of bidding.

Three basis points may not sound like much, but for a five-year note auction, this is rare. It was the largest such "tail" since June 2022. Analysts at JPMorgan noted that you’d have to go back to 2011 for a prior instance of a three-basis-point "tail" at a five-year auction—when a looming debt ceiling crisis ultimately led to a U.S. credit rating downgrade that August.

Looking to the present, concern about the dire U.S. fiscal outlook is pushing long-term borrowing costs higher. Therefore, there is broad market expectation that the Trump administration will gradually shift the Treasury’s massive funding needs toward the lower end of the yield curve—where costs are cheaper and maturities are shorter.

This is why the five-year note auction two weeks ago caused such alarm. A three-basis-point "tail" is common for long-maturity bond auctions but not for those in the so-called "belly" of the yield curve. If the Treasury is forced to pay much higher premiums to issue these bonds, then, Houston, we have a problem.

An unusually large auction "tail" can be caused by a variety of factors, including market volatility on the day of the auction, or, more worryingly, fundamental issues that could erode demand over time. These are often difficult to distinguish because they are not mutually exclusive.

On the brighter side, this anxiety has not yet spilled over into the short end of the curve—at least, not at this moment.

Three- and ten-year Treasury yields have risen about 50 basis points since the last auction a month ago, hovering at roughly 4.96% and 5.32%, respectively. The thirty-year yield has climbed about 35 basis points to 5.65%. These levels should be high enough to attract strong demand and ensure smooth sales, right?

Probably. But should unforeseen developments occur, volatility and uncertainty could ripple through the entire market. Investors will be watching developments as closely as hawks.

(The views expressed in this article are those of the author alone, who is a Reuters columnist.)

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