Last February, we asked the question: who will buy all of this US debt?
With the demand for US Treasuries dropping precipitously as the US Treasury floods the market with paper, it’s time to revisit that question.
With the US running huge deficits every month, the Treasury Department is selling bonds at a dizzying pace. Long-term US debt sales have risen to a level not seen since the height of the financial crisis. In November alone, the US Treasury sold over $200 billion in public debt. The department sold bonds at an average rate of $123 billion a month in the six months between June and November. This pace of borrowing is expected to continue into 2019.
Meanwhile, the three biggest holders of US Treasuries – China, Japan and the Federal Reserve – are dumping bonds, not buying. Chinese holdings of US Treasuries dropped for the fifth straight month in October (the most recent data), sinking to the lowest level since May 2017.
So, it should come as no surprise that global demand for US debt is sinking.
As Bloomberg recently reported the “bid-to-cover ratio” fell even as Treasury yields rose in the last quarter of 2018. According to the report, “of the $2.4 trillion of notes and bonds the Treasury Department offered last year, investors submitted bids for just 2.6 times that amount.” That’s less than any year since 2008.
“The drop-off is an early warning that demand for Treasuries may not keep up as the US goes deeper into the red.”
In the first auction of 2019 featuring a $38 billion sale of 3-year Treasuries, demand fell to a near-decade low.
The most recent 30-year Treasury auction also continued a downward trend. The bid-to-cover ratio slumped to 2.19, down from 2.31 in December, the lowest since November, which in turn was the lowest since August 2011, according to ZeroHedge.
In another sign of sagging demand, the 30-year offering ended as a “tailing” auction, meaning the yield finished higher than the prevailing market rate for the bonds at the time bids closed. Simply put, this indicates buyers needed a higher yield to entice them to buy, signaling lower demand for the bonds.
There was also a surprising slump in the number of foreign buyers during the most recent 30-year action. The number of indirect bidders fell sharply from 66.3% in December to 57.3%, well below the six auction average of 62.6%. It represented the lowest indirect/foreign demand in over two years.
Deutsche Bank chief international economist Torsten Slok told Bloomberg that this weakness in demand “doesn’t matter until it suddenly does.”
“A declining bid-to-cover ratio increases the vulnerability and probability that investors suddenly will begin to think that a falling bid-to-cover ratio is important. Put differently, all fiscal crises begin with a declining bid-to-cover ratio.”
To some degree, one might expect the bid-to-cover ratio to shrink because the US Treasury is selling so many more bonds in order to finance the ballooning national debt. It’s basically flooding the market with bonds. The Treasury enlarged its auctions for four straight quarters. And as Bloomberg noted, “the US has grown more reliant on the public to finance its deficit as the Federal Reserve scales back its purchases of Treasuries to shrink its $4 trillion of crisis-era bond holdings.” As one analyst said:
“We’ve seen record high auction sizes, so decade-low bid-to-cover makes sense. I would expect, mechanically, for bid-to-cover ratios to come down, just because there’s not endless, insatiable demand out there for Treasuries.”
So, what difference does it really make?
It ultimately comes down to interest rates. As supplies increase and demand falls, bond prices fall and yields go up. ZeroHedge put it in pretty stark terms.
“Considering that the US continues to sport the lowest FX-hedge adjusted yields of the entire developed world, it is only a matter of time before the creeping foreign boycott of US paper (and funding the US deficit) becomes a major issue, and will likely require much higher yields.”
Rising bond yields tend to pull other interest rates up with them. Rising interest rates aren’t good news in an economy built on debt.