U.S. government borrowing runs into resistance
Investors have started to balk at absorbing large quantities of U.S. government debt, taking on substantial inflation and devaluation risk in return for little reward. While the government has no trouble placing short-term debt with a maturity of up to 2 years, longer-dated securities are proving much harder to sell.
Increasing resistance from the market explains why the Federal Reserve felt it had no choice but to announce it would start buying back longer-term U.S. Treasury securities last week, in a $300 billion program of direct quantitative easing and monetization.
The attached chart (https://customers.reuters.com/d/graphics/TREASAUCTIONS.pdf) shows the amount of 10-year U.S. Treasury debt placed at each of the auctions since the beginning of 2008, the interest rate which the government offered (coupon yield), and the range of rates (high, low, median) the market actually accepted through the auction process.
The government has been steadily cutting the coupon rate on offer from 4 percent in September 2008 to 3.75 percent in January 2009 and 2.75 percent at the auctions held in both February and March. But the market’s appetite for longer-term debt at such low interest rates has been waning.
The median yield which the market has demanded in the auctions has risen steadily from 2.35 percent in January to 2.71 percent in February and 2.98 percent in March. The high yield is up from 2.42 percent in January to 3.04 percent in March.
The March auction results show the government’s borrowing program was in increasing trouble. The median yield the market accepted (2.98 percent) was 23 basis points above the coupon the government was offering (2.75 percent); the government was forced to place the issue at a substantial discount (the debt was sold for an unusually large discount of 2.49 percent to its face value, or just 97.50 cents on the dollar).
The ratio of bids placed to securities sold (the “bid-to-cover” ratio) was also very low in both February and March (2.2 bids to every 1 sold), confirming that investors were looking for more yield than the government was readily paying.
Moreover, the proportion of securities purchased by primary bond dealers for their own account (60 percent) was down sharply in these auctions compared with last year (when 70-80 percent was normal). Instead, large shares went to indirect bidders (35-37 percent) which include foreign central banks bidding through the Federal Reserve Bank of New York, which may not have strictly commercial motives. The residual went to direct bidders via the primary dealers.
In the absence of the Fed move, the government would almost certainly have needed to raise its coupon from 2.75 percent to 3 percent or even higher at the next auction. It would have reversed the downtrend in place since last autumn and sent a powerful signal to the market that lack of demand was driving long-term interest rates higher.
The buy-back program — targeting 2-10 year Treasury securities — looks like an attempt by the Fed to forestall a rise in coupon payments that would otherwise have been inevitable, triggering a sharp rise in long-term borrowing costs across the economy.
But the program’s likely effectiveness is open to question. Yields on 10-year Treasuries have already risen more than 20 basis points from last week’s lows, and are now just 30 points below the level prior to the Fed’s announcement. Given the size of the government’s borrowing needs — which dwarfs the $300 billion buy back program — the program is unlikely to hold back the rise in yields for long.