Treasury Auction Madness

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Treasury auction madness.  This was inspired by posts on X.com and a Wall Street Journal Article (“Why Treasury Auctions Have Wall Street on Edge” December 10 2023). The issue is the limit on the amount of debt the U.S. government and global economy can handle.  The phrase “failed Treasury auction” sounds ominous because, well, it is. Here’s the introduction:

The U.S. Treasury prefers its debt sales to be humdrum affairs. Lately, they are sparking fireworks in markets.

Scrutiny of Treasury auctions—whereby the government funds operations by selling the world’s safest bonds to big banks and dealers—has grown alongside their size. For years, many in Washington and on Wall Street assumed that investors would buy any number of bonds the government issued, no matter the fiscal outlook. Testing that assumption: the,msale of $20.8 trillion of new Treasurys in the first 11 months of the year—set to surpass 2020’s record of just under $21 trillion.

Ever since U.S. government spending began skyrocketing during the COVID pandemic, serious economists have been increasingly worried about the state of the U.S. Treasury securities market.  Here’s why:

Debt to GDPTreasury Auction Madness

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Debt to GDP peaked in 2020 largely because GDP fell while debt rose sharply.  The decrease since then was completely caused by the GDP rebound.  Debt has continued to rise:

Debt Treasury Auction Madness

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The Penn Wharton Budget Model estimates a maximum debt to GDP ratio of between 175% and 200%.  Those folks are experts and I believe their estimates are the best available.  But let me add one thought.

The Importance of Expectations

A market will often collapse slowly at first, then suddenly.  One of the main reasons is expectations.  Customers, stockholders, and/or suppliers can cause the collapse.  It’s usually based on expectations, real or imaginary. Customers may lose faith in the product’s quality or the firm’s ability to provide support in the future.  Stockholders worry that the firm may go bankrupt, reducing the value of their holdings to zero.  Suppliers may insist on COD terms rather than extending credit.  In all these cases, the uncertain future can sink a firm, market, or government faster than you might think.

The U.S. Government

Those who want to understand the mechanics of a Treasury auction should read the Wall Street Journal article linked above.  Here I want to focus on some jargon used to describe events during an auction.  Here’s how the Journal describes those events.

Wall Street has its own lingo to describe how an auction went. When the yield is higher than expected? Investors call that a “tail.” When it’s lower, that is a “stop-through.” Auctions that meet expectations are said to be “on the screws.”

Last month’s 30-year auction had a massive tail by historical standards. Primary dealers bought nearly a quarter of the issuance, more than double their average. The previous 30-year auction also didn’t go well.

Few fear an outright auction failure. That is an unlikely scenario that analysts said could potentially kick off prolonged and catastrophic market turmoil.

Investors gauge demand at an auction by looking at the “bid-to-cover” ratio. That measures the size of buyers’ orders—or bids—against how much money the Treasury is looking to raise. The higher the ratio, the better. There are always enough buyers; the worry is that they’ll demand elevated payouts.

Conclusion

That’s the whole deal.  A failed auction means Treasury is unwilling or unable to offer bonds at a price that will induce buyers to make the purchase.  (Reminder: bond prices and yields move in opposite directions.  A lower bond price means a higher yield.)  As things now stand, Treasury is being forced to offer higher yields than they would like.  Repeating a key paragraph,

Last month’s 30-year auction had a massive tail by historical standards. Primary dealers bought nearly a quarter of the issuance, more than double their average. The previous 30-year auction also didn’t go well.

Buckle up.  It’s gonna be a rough ride.

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About Tony Lima

Retired after teaching economics at California State Univ., East Bay (Hayward, CA). Ph.D., economics, Stanford. Also taught MBA finance at the California University of Management and Technology. Occasionally take on a consulting project if it's interesting. Other interests include wine and technology.