The Treasury market’s nascent rally is facing its next big test: a bond auction that will help gauge whether investors are confident 2023’s selloff is over once and for all.
Spurred by slowing inflation and signs of a cooling growth, traders and investors have recently rushed headlong into US government debt, convinced that the Federal Reserve is done raising interest rates and will shift to cutting them by the middle of next year. That’s ended a six-month losing streak for Treasuries and pushed the market to a gain of 2.6% in November. It’s the biggest advance since March, when there were fears that a banking crisis would sink the economy.
But this month’s advance has driven yields to the lowest levels since September, turning the demand at Monday’s 20-year auction into an indicator of whether investors see a risk the recent trend will reverse. Such concerns were evident in the 30-year auction earlier this month, when the market briefly tumbled after the Treasury had to offer an unusually large yield premium to sell the securities.
The Treasury’s 20-year bond has been an albatross for much of its three-year existence, during which it has never been sold during the holiday-shortened US Thanksgiving week. So a strong reception would be a particularly powerful endorsement of the rally.
The sale “will be a good sanity check for the notion that the evolution of data has in a meaningful way shifted to more stable/constructive for how duration supply gets absorbed,” said William Marshall, head of US interest-rate strategy at BNP Paribas.
The confidence of traders has been rattled over the past year as the surprisingly strong economy and stubborn inflation quashed several rallies that broke out on speculation the Fed would stop raising interest rates. The swelling federal deficit — which is testing the market’s capacity to absorb all the new debt that’s financing it — has also played a role.
But this month signs that the labor market is cooling and inflation is being reined in has strengthened conviction that the central bank’s monetary policy is sufficiently restrictive. At the same time, the auction size increases the Treasury announced were smaller than many bond dealers expected, particularly for long-maturity offerings, easing some of the supply concerns.
The 30-year bond auction on Nov. 9 nonetheless drew a much higher-than-expected yield, a sign of weak demand that fueled a major selloff in the market that day. That downturn, however, proved brief, rewarding investors as the new bonds went on to rally, sending the yield from a starting level of about 4.77% to as low as 4.56% this past Friday.
While the 20-year Treasury bond has consistently suffered from weak demand — keeping yields above those on 30-year bonds — Marshall said it has been faring better in auctions since the Treasury reduced its size relative to the 10- and 30-year counterparts. Monday’s auction is for $16 billion, compared with $24 billion for the 30-year sale this month.
Even so, the 20-year has failed to keep pace with the Treasury market’s recent gains, a sign of awareness that next week’s auction might otherwise be a hard sell.