Q&As About Treasury Auctions & Weak Demand for 30-year Treasuries
On November 9, the US Treasury was scheduled to issue $112 billion in new securities, including $24 billion in new 30-year Treasury securities, which it does through auctions. However, demand for 30-year Treasuries appeared weak, as there weren’t as many buyers as expected. This resulted in some short-lived but wild speculation in the World Wide Web and even on Capitol Hill about what happened. Markets for Treasury securities are quite complex. My colleagues Jessica Paska and Abraham Ourth asked me some questions about the US Treasury market, which I answer below as a way to provide basic information about how US Treasury securities auctions work, what recently happened and what that might mean going forward.
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1. What does Treasury auction and why? How frequently does this occur?
The US Treasury sells newly issued marketable debt securities through auctions to help fund government budgets.
The standard view about government budgets holds that the spending gets funded through: 1) a variety of taxes, 2) changes in the money supply or “seignorage”, and 3) changes in debt when the Treasury issues new marketable securities through auctions.
Marketable Treasury securities include so-called “on-the-run” securities, which are sold in auctions; they’re like the new cars of the Treasury securities market. Previously issued Treasury securities, also called “off-the-run” Treasury securities, are like the used cars of the Treasury securities market. When the US Treasury issues new marketable securities, they come with a variety of terms, such as Bills (with current maturities of 4-, 8-, 13-, 17-, 26-weeks), which are auctioned off weekly, and Notes (with maturities of 2, 5 or 7 years) and Bonds (with maturities of 10, 20 and 30 years), which are auctioned off monthly. The US Treasury posts some auction results here.
2. Who is a typical buyer? What happens to the debt that doesn’t get sold?
Potential buyers worldwide of US Treasury securities include individual investors (you can open a TreasuryDirect account and participate yourself), institutional investors (such as mutual and pension funds, as well as hedge funds), foreign central banks and governments, and banks including primary dealers (see https://www.newyorkfed.org/markets/primarydealers).
Incidentally, primary dealers also serve as counterparties when the Federal Reserve System, through the Federal Reserve Bank of New York (FRBNY), conducts monetary policy using open market operations of existing (“off-the-run”) Treasury securities. Here, the FRBNY swaps primary dealer holdings of Treasury securities with reserves or vice versa. When it purchases Treasury securities from a primary dealer, it adds back an equal amount of reserves to the primary dealer’s FRBNY account. When it sells Treasury securities to a primary dealer, it subtracts an equal amount of reserves from the primary dealer’s FRBNY account. If, as happened this month, the Treasury auction for new (“on-the-run”) securities doesn’t get fully sold (more on that below), primary dealers buy up the remainder to be held as inventory for future transactions.
3. How much of the debt is owned by foreign investors?
As of the writing of these answers, the most recent release in August 2023, indicates that about $7.7 trillion in US Treasury securities were held abroad, with $3.7 trillion of that held by officials (central banks or governments). In August 2023, there was $26 trillion in debt held by the public and $6.87 trillion in intragovernmental holdings, for a total of $32.9 trillion in total public debt outstanding. Total foreign holdings, including foreign official holdings, made up 29.6 (23.4) percent of debt held by the public (total public debt outstanding). Foreign official holdings made up 14.2 (11.2) percent of debt held by the public (total public debt outstanding).
Treasury Auction on November 9
4. What happened during the November 9th auction?
To set the stage for the November 9th auction, with persistent US government budget deficits and higher rates of inflation, bond and stock market participants have been paying close attention to monetary policy decisions by the Federal Reserve; lately, some key Wall Street figures have even publicly stated that market participants are perhaps paying too close attention to future monetary policy decisions, while ignoring the underlying fundamentals. That has made prices for longer-term Treasury securities, stocks and other asset classes more volatile, as market participants are still guessing about whether the Federal Reserve will continue to raise or lower policy rates in response to inflation rates.
On 11/9/2023, the US Treasury was scheduled to issue $112 billion in new securities, including $24 billion in 30-year Treasury Bonds. However, demand for 30-years appeared weak, which meant that the primary dealers had to take on more than they wanted. Longer-term US Treasury and stock prices dropped more than usual that day, likely because investor sentiment reflected concerns that the Federal Reserve would be more likely to raise policy rates. The primary concern with weak long-term Treasury security demand remains that it’s yet another signal that they may be harder to sell, especially given the persistent deficits and higher than usual rates of inflation. In the still unlikely event that no one buys new Treasury securities, we could have a Treasury securities crisis, which could spill over to all other securities markets worldwide.
As a subsequent counter-example about investor sentiment, just five days later on 11/14/2023 after the monthly Consumer Price Index (CPI) report came out, investors likely interpreted the slightly lower than expected CPI print as a sign that the Federal Reserve will be less likely to raise policy rates further. Longer-term US Treasury and the stock prices rose more than usual that day.
5. What are reasons that lead to weak demand?
Since the 1790s, factors that have made US Treasury securities attractive to investors relative to other securities include the fact that they are considered by investors to be mostly safe from credit/default risk. But from an investor’s perspective, Treasury securities are exposed to interest rate risk since bond prices fall when interest rates rise, too. Given that nominal interest rates tend to move in the same direction as inflation rates, since the rate of inflation began rising in mid-2021, that put downward pressure on global investor demand, such that there has been downward pressure on bond prices. What happened on 11/9/2023 reflected added concerns about the relative attractiveness of holding longer-term US Treasuries. In addition, investors do not like Treasury security illiquidity risk that “off-the-run” securities have, in the sense that, just as with a used car, there may not be as many willing buyers, especially for longer-term Notes and Bonds.
6. What is the significance of the funding with more shorter term debt, rather than 30-year bonds?
If there’s less relative demand for longer-term Notes and Bonds going forward, that will mean the Treasury will have to rely more on short-term funding, through Treasury Bills. Greater reliance on shorter-term funding can increase debt roll-over risk, the risk that newly issued (short-term) marketable Treasury securities might not be absorbed by market participants, which could mark the start of a Treasury securities crisis.
7. What will this weakening demand for Treasuries do for borrowing costs/interest rates?
Weakened demand typically manifests itself in declining prices for marketable Treasury securities, and given the inverse relationship between yields and prices, rising yields. Holding everything else constant, interest expenses would go up.
8. Do trends like this risk US debt losing its status as a reserve currency (changed risk-free asset to reserve currency)?
A reserve currency is a currency that is widely held by central banks and other monetary authorities as foreign exchange. If a country with a reserve currency status becomes fiscally irresponsible, over time that undermines demand to use that currency for existing purposes, which could ultimately result in a reserve currency being replaced by suitable alternatives. As with previous reserve currencies, such as the British pound, that could happen to the US dollar in the future.
9. Why should policy makers be concerned with the auction and the effects of the auction?
One poor auction could just reflect concerns about inflation, and whether the Federal Reserve will continue to increase policy rates, on holdings US Treasury securities. If this continues to happen, it could also mean there’s a growing concern about the sustainability of US Treasury debt.
10. What can Congress, the US Treasury and the Federal Reserve do?
Any weak demand for Treasury securities, as happened recently with 30-year Treasuries, likely reflects investor concerns about the Federal Reserve’s monetary policy decisions. To the extent that it persists, this could also reflect concerns about the future sustainability of US debt, given the US government’s persistent budget deficits. Ultimately, this problem lies with Congress, which will have to address it by increasing tax revenues AND reducing spending, an unpopular policy mix on Capitol Hill.
There’s not much for the Treasury department to do, since it engages in debt management, given persistent government budget deficits: it does its best to issue marketable securities to investors to fund deficits, while also attempting to keep interest payments to investors lower rather than higher.
The Federal Reserve can do even less. It has Humphrey-Hawkins mandates to maintain price stability and full employment, which it does through open market operations and generally avoids interfering with Treasury debt management since the Treasury Fed Accord in 1951.
Last month, I discussed the ominous outlook for the banking sector, and Moody’s recently downgraded the ratings for Bank of America, JP Morgan and Wells Fargo, out of concerns that the US government may not be able to support them in a crisis. The ongoing Congressional gridlock to address persistent budget deficits fuels those concerns, especially when the largest banks have relatively little equity capital, as I showed earlier this year. Simpler, higher equity capital requirements would eliminate the added concerns about bank failures amidst the ongoing budget gridlock.
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