Pressure on long-term U.S. Treasury demand is intensifying.
On Thursday, the U.S. Treasury auctioned $25 billion in 30-year bonds, with the high yield reaching 5.216%, the highest level since 2001. The auction also saw a "tail" where the high yield exceeded the pre-auction yield, indicating investors demanded higher returns to take on the debt, with demand slightly weaker than market expectations.
Before the auction results were released, the 30-year yield in the secondary market fell about 5 basis points intraday on Thursday. After the results, the yield decline narrowed slightly, and the yield curve steepened further. The spread between 5-year and 30-year yields widened, remaining at its widest intraday range since May.
This marks the second consecutive long-term Treasury auction this week with a high yield hitting a multi-year high. On Wednesday, the Treasury completed a $42 billion auction of 10-year notes, with a high yield of 4.683%, the highest since the 2007 global financial crisis, also slightly above the pre-auction yield.
These two auctions, both at historically high yield levels, highlight the growing challenge of market absorption for long-term Treasuries as the U.S. government's borrowing costs continue to rise. Notably, even with the July CPI data not significantly boosting short-term rate hike expectations, long-end yields remain elevated. This suggests that factors beyond Fed policy expectations, such as fiscal supply, inflation risk, and term premiums, are now driving yields higher.
Small 'Tail' Appears in 30-Year Treasury Auction
The $25 billion 30-year Treasury auction on Thursday was settled at a yield of 5.216%. This level was 0.4 basis points above the pre-auction yield of 5.212%. Bond traders refer to this situation, where the auction yield exceeds the pre-auction yield, as a "tail," indicating that the Treasury had to offer a slightly higher yield than the market's pre-auction pricing to complete the sale. It is a key indicator of whether demand is stronger or weaker than expected.
The 0.4 basis point tail was relatively small, but the direction is noteworthy. Despite the 30-year yield being about 5 basis points lower than the previous trading day, investors did not actively snap up the bonds at the lower market yield. Instead, they demanded higher yields to execute the trade.
Other metrics also showed a divergence in demand. The bid-to-cover ratio for this auction was 2.39 times, above the average of 2.36 times for the previous six comparable auctions, suggesting demand was not weak on the surface. However, the buyer structure changed. The allocation for indirect bidders, a proxy for foreign investor demand, including foreign central banks, was 66.8%, down from the near-record 77.7% in July and the average of 67.0% for the previous six auctions. The allocation for direct bidders was 21.6%, slightly below the recent average of 22.5%. The allocation for primary dealers, who act as backstop buyers, rose to 11.5%, up 150 basis points from July and slightly above the recent average of 10.6%.
Primary dealers typically absorb the portion of an auction not taken by final investors. A rise in their allocation, combined with a decline in indirect bidder participation, suggests that some demand had to be taken up by primary dealers. The auction had several positive factors, including the high absolute yield on the 30-year bond, the demand seen in Wednesday's 10-year note reopening, and the relative value opportunity offered by the day's yield curve. However, the 30-year bond itself did not offer a sufficiently clear yield concession, which may have been a key reason for the slightly weaker-than-expected demand.
Consecutive Long-Term Treasury Auctions with Multi-Year High Yields
Wednesday's 10-year Treasury auction had already sounded a warning. The U.S. Treasury issued $42 billion in 10-year notes at a high yield of 4.683%, the highest since 2007, and a sharp increase of 10.3 basis points from the 4.580% in the previous month's similar auction. Compared to the 30-year auction, the 10-year auction had a "tail" of only 0.1 basis points, with the high yield of 4.683% slightly above the 4.682% pre-auction yield. Therefore, demand could not be easily defined as weak. Market reports also noted that overall demand for this auction remained solid, with the allocation to primary dealers falling, indicating that final investors still had some capacity to absorb the bonds.
More notable, however, is the yield level itself. Even though the July U.S. CPI headline and core inflation figures were in line with expectations, and the core CPI year-over-year rate of 2.5% was the lowest since March 2021, the auction yield for the 10-year note still rose to its highest since 2007. This means the long-term bond market is exhibiting a pricing logic different from short-term Fed policy expectations.
Market analysts also pointed out that after the July inflation data release, market expectations for a Fed rate hike in September cooled, but the 10-year yield remained high, and the yield curve continued to steepen.
Beyond 'Rate Cut Expectations,' Fiscal Supply and Term Premiums Become Key Variables
For some time, the rise in Treasury yields was largely tied to a repricing of the Fed's rate cut path. However, recent market performance indicates that monetary policy expectations alone are increasingly insufficient to explain the elevated long-end yields. On one hand, the U.S. government still needs to continuously issue large amounts of debt to finance its massive fiscal deficit. On the other hand, concerns about inflation risk, energy prices, and long-term fiscal sustainability may prompt investors to demand higher term premiums.
It is particularly noteworthy that 10-year and 30-year Treasury yields have remained high even after recent relatively benign inflation data. Market analysis suggests this reflects a growing sensitivity of long-term bonds to fiscal deficits, Treasury supply, and inflation risk. Looking at the yield curve, after Thursday's 30-year auction, the spread between 5-year and 30-year yields widened further, remaining near its widest since May. This rise in long-end yields relative to short-end yields indicates that the market is demanding more compensation for holding long-term U.S. government debt.
For the U.S. Treasury, this presents a more practical problem: in a high-deficit and high-debt environment, the government needs to issue more long-term debt, but the cost of financing demanded by investors is also rising.
The 'Safe Asset' Halo of Treasuries Faces Dual Tests of Supply and Cost
This 30-year auction alone is not enough to suggest a systemic collapse in demand for U.S. Treasuries. After all, the bid-to-cover ratio of 2.39 times was still above the average for the previous six new 30-year bond issues, and the 0.4 basis point tail was a relatively limited magnitude. However, when looking at the two auctions on Wednesday and Thursday together, the signal becomes more concerning: the high yields for the 10-year and 30-year bonds hit their highest levels since 2007 and 2001, respectively, and both auctions showed yields slightly above their pre-auction yields.
This means the U.S. government is borrowing at yield levels rarely seen since the financial crisis or even the early 2000s, and the market's absorption of new long-term debt has not been overwhelmingly strong despite yields reaching these highs. Against a backdrop of ongoing Fed policy uncertainty and a widening U.S. fiscal deficit, the ability of future medium- and long-term Treasury auctions to maintain stable demand will be a key window to observe whether long-term U.S. borrowing costs will rise further.
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