Thursday’s auction data for the 10-year U.S. bond was slightly weaker than expected, but still showed stronger demand and a slightly more stable bond market.
According to market operator ICAP, the overnight repo rate for the 10-year Treasury note was quoted at around -1.60%/-1.85% on Thursday, compared to -1.75%/-2% quoted earlier by Break Capital.
Then early Friday morning, the results of the tender sale of 30-year U.S. bonds came out, and the winning rate was 2.295%, much higher than the previous value of 1.933%, indicating an increase in market demand. But JPMorgan Chase is not convinced, JPMorgan Chase overnight interest rate market analyst Jay Barry recently issued a research report, warning that the supply of U.S. bonds is too large, the market will have difficulty absorbing the excess supply.
Barry said bond auctions are 50-95% larger than they were a year ago, and he sees evidence that “supply has become somewhat excessive and difficult for the market to absorb, especially in the last month, when U.S. bond yields have deviated from fundamental drivers.”
He then tallied end-user demand for bonds from 2014 to 2021, and the data showed a slowdown in end-user demand in 2021, with the more prominent being demand for 5-10 year intermediate term bonds, but still slightly above the average observed over the past few years.
He noted that most end-user demand comes from investment management companies. In recent years, management companies have accounted for 50-60% of the total demand for auctions and demand for long-term bonds is higher than for short-term bonds. Also, in terms of foreign demand, although foreign investors’ demand for short-term bonds has rebounded recently, their overall demand for bonds has come down from its highest point in the past 10 years.
Despite considerable end-customer participation, primary market dealers have doubled their duration over the past year, yet have very limited risk-taking capacity. (Duration, the average Time for bondholders to recover their full principal and interest, is a measure of interest rate risk.)
Disturbingly, buyer demand in the primary market has declined, particularly in the 5-year, 7-year and 20-year bond markets.
But Barry notes that the bond market is still benefiting from strong end-customer demand right now, with the share of auction demand from end-customers in 2020 10-20% higher than the 2014 average; and in 2021, while their participation in the 7- to 20-year bond market has declined, “this is the most aggressive year for auction size growth “
Barry believes that further increases in Treasury yields should be driven by medium-term 5 to 10-year Treasuries, not long-term Treasuries, and that the biggest drop in U.S. bond yields over the past six months occurred two weeks before the medium-term U.S. bond bid, with a more moderate rise in U.S. bond yields near the end of the month after the mid-month delivery.
At the same time, he also pointed out that while the share of demand from primary market dealers in the auction has not declined significantly over the past year, the duration has doubled and their ability to take risk has not increased, so there is still a lot of uncertainty in the bond market going forward.
On Thursday, the 30-year Treasury auction won a bid at 2.295%, up 36.2 basis points from the previous month. The bid multiple, a measure of demand, was 2.28, lower than the average of the last six at 2.336, but higher than last month’s 2.176. Analysis suggests that this may be due to a $3 billion reduction in the size of the bid, but in reality the supply of U.S. debt remains large, and according to the analysis of the Small Business Administration, the market’s ability to absorb the huge supply is limited.
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