Why the Treasury Auction Wasn’t So Ugly

By: Uri Estrin - August 14, 2020 10:29am EST
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Speak volumes of a very distorted market
Speak volumes of a very distorted market

Yesterday’s Treasury Auction has been labeled as ‘ugly’ by bond market watchers. Here’s what happened: The auction was only 2.14 x subscribed (usually around 2.5) and Dealers took a larger percentage of issue. Yields from the 10yr to the 30yr spiked, sharply.

The sentiment was such, that not as many indirect bidders stepped up to bid and primary dealers had to take up the slack. This spooked bond markets as this was the largest issue ever and could show cracks in the market of not being able to absorb enough of the issuance. The result would be higher rates to entice borrows.

This was happening at the same time as the S&P was racing toward an all time high. You can’t have both.

The spike in yields wasn’t because of better than expected jobs numbers or a jump in CPI or a jump in sentiment or consumer spending. No, all of those numbers were still relatively tepid and passed the market without much movement. The spike was out of fear. The US Government is issuing debt at an amazing clip. On top of the exploded deficit, $3T in stimulus requires record Treasury issuance. The markets questioned if there is enough appetite to absorb all the issuance.

The treasury market is viewing this in a vacuum. The S&P is leaping up not on profits or future profits but based on stimulus. This is evidenced from the claw back from the March lows. But here’s the thing, you can’t have a roaring stock market based on stimulus bets and a bond market squirming from over-issuance. If rates are going higher, or worse, if the market cracks, then there won’t be enough cheap stimulus money to pour into stocks. Can’t have it both ways.

This is also on top of record low corporate bond issuance. Visa issued a 7yr bond 0.75%, the lowest spread above treasuries. Ball Corp issued 10yr junk bonds at 2.875%, a record low for junk bond issuance.

If there is apparently no appetite for Treasuries, then it sounds like a very distorted market if junk bonds are the flavor du jour over Treasuries. It speaks volumes of a very distorted market. Remember, the 30yr auction was still 2.14x over subscribed and it’s a closed auction designed to favor the dealers.

Stimulus has once again pushed investors to chase yield at the expense of safety. The markets all around are distorted. When something breaks, it won’t be Treasuries, quite the opposite, when the chips are down, the rush to safe Treasuries turns into a stampede. Yields will most likely come down again, long before that.

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