(C) Reuters. The U.S. Yield Curve Is Holding Up for Now
(Bloomberg Opinion) — The U.S. Treasury Department rarely surprises bond traders when it announces its borrowing plans for the coming quarter. But like many things during the coronavirus pandemic, precedents no longer seem to apply.
Staring down a budget deficit approaching $4 trillion, Treasury Secretary Steven Mnuchin unveiled a plan Wednesday that starts to focus overall issuance increases on longer-term debt. The U.S. will auction $32 billion of 10-year notes, more than the consensus expectation for $29 billion, and $22 billion of 30-year bonds, more than the forecast of $21 billion. In perhaps the most stunning move of all, the Treasury will revive the 20-year bond for the first time on May 20, with an initial offering size of $20 billion, blowing away Wall Street calls for somewhere between $12 billion and $14 billion.
Tom Simons at Jefferies (NYSE:JEF) LLC summed up the market’s surprise:
“Although we have argued many, many times in the past for Treasury to increase issuance at the long-end of the curve as interest rates have fallen to historically low levels, Treasury’s past actions and guidance have suggested an extreme reticence to do so. Despite overwhelming evidence that a move towards increasing long-term issuance in the current environment was more appropriate than ever, we still thought they would shy away from this decision. However, Treasury did not. So, in some sense, this is a situation where we are glad to be wrong because this is the most appropriate decision for Treasury in the long-run. Issuing trillions of dollars in bills on a monthly basis is not sustainable for any length of time and efforts to term that debt out should be increased immediately while the opportunity presents itself.”
Predictably, bond traders quickly sold longer-dated Treasuries. The benchmark 10-year yield rose 7 basis points to 0.73%, the highest since mid-April, while 30-year yields jumped as much as 10 basis points to 1.43% in the largest move since April 7. The yield curve from five to 30 years steepened to more than 100 basis points. Aside from a day when Treasuries malfunctioned during the worst of the market turbulence, that’s the steepest since September 2017. The spread between two-year and 10-year yields (again, a few wild days in March notwithstanding) is the widest since early 2018.
Intuitively, this knee-jerk reaction seems to make sense. Investors need to absorb a larger amount of long-term debt than they were expecting, and so they naturally expect to receive a higher yield to take down those securities.
At the end of the day, though, the typical Econ 101 supply-demand dynamics don’t truly apply to Treasuries. The U.S. government controls the world’s reserve currency, and the Federal Reserve is committed to buying whatever is necessary to ensure a smooth-functioning market. An extra few billion dollars here and there is simply not enough to permanently move the needle when the nation’s marketable debt outstanding is $17.2 trillion.
In other words, it will take more than this bump up in auction sizes to further steepen the U.S. yield curve. Specifically, bond traders will need to see evidence that the American economy is on the verge of recovering from an unprecedented slump in activity and a record increase in unemployment. They’ll also need signs of a buildup in inflation — certainly a possibility if and when the country turns a corner, but hardly a concern at the moment.
Until those things happen, Wednesday’s increase in Treasury yields will likely be a one-off move rather than the start of a broader trend. Longer-term yields at their most basic level reflect expectations for short-term interest rates over a number of years. Nothing about the way the U.S. is going about financing its deficits changes the outlook for the Fed’s path of monetary policy. As Chair Jerome Powell made clear last week, the central bank will keep rates near zero long after the coronavirus pandemic subsides.
It’s also worth noting that for all the focus on the long-end, two-year Treasury yields dipped on Wednesday to near the lowest since 2011 and five-year yields barely budged. That follows auctions of the two maturities last week that saw the strongest demand in years, even with yields at or near record lows and issuance at or near record highs.
Doomsayers may use this announcement of a sharp increase in long-term debt to raise the specter of failed Treasury auctions. That’s not going to happen for any number of reasons. For one, the Fed is in the market like never before, and it will take down the longest maturities if it has to. Also, for those concerned about Wall Street primary dealers cracking, that peaked as a potential issue in March. At this point, the Fed has intervened not just by purchasing Treasuries but also importantly by changing its supplementary leverage ratio rule so financial institutions can exclude U.S. Treasuries from that calculation. Banks can take Treasuries with confidence that they won’t need to suddenly sell them at an inopportune time. Not that they’ve had a heavy burden: Primary dealers’ share of April’s 10-year and 30-year debt sales were right in line with the average over the past year.
Put it all together, and the Treasury’s new focus on long-term debt hardly seems backbreaking for anyone. The yield curve won’t steepen on supply alone. Investors considering wading into or out of the world’s biggest bond market should use their projections for how the American economy comes out of its coronavirus lockdown to guide their decisions. Auction sizes are mostly just a distraction.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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The U.S. Yield Curve Is Holding Up for Now