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Weakest US bond auction in decade validates Dimon’s warning

[NEW YORK] The US Treasury on Wednesday saw the weakest demand for its benchmark 10-year note in a decade, illustrating the diminishing appetite among some investors to accept current yields.

Bids for the US$27 billion of notes exceeded the offering by 2.17 times, the lowest since 2009. While there's no danger that the government of the world's biggest economy would fail to fund itself, the drop underscores a shift in demand dynamics for Treasuries that could leave them vulnerable to spikes in volatility.

Foreign investors, led by China and Japan, have accounted for a smaller and smaller share of American government debt outstanding. And the Federal Reserve, for now, continues to trim its holdings. That's put the onus on domestic US investors, at a time when 10-year yields are little more than three-month ones.

"Extraordinarily low'' is how JPMorgan Chase & Co chief executive officer Jamie Dimon described the current level – 2.46 per cent in Asian trading on Thursday – in an interview with Bloomberg Television on Wednesday. Large-scale asset purchases by central banks "had to have an effect on the 10-year,'' he said.

The so-called quarterly refunding sale of 10-year notes on Wednesday drew a yield of 2.479 per cent, above the prevailing level moments before the bidding deadline. And primary dealers, which trade directly with the New York Fed, were stuck with the biggest chunk of a sale of this maturity in a year.

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While there was some speculation that rising US-China trade tensions could see Chinese buyers holding off at the auction, there was no obvious sign of that. Indirect bidders, the category that includes foreign and international monetary authorities placing bids through the New York Fed, took 53.3 per cent of the sale, the least since April 2018. But direct bidders, "widely understood to be mostly driven by China," according to Thomas Simons, an economist at Jefferies, took a near-average share.

Even so, the broader share of foreign ownership of Treasuries has steadily dropped over time, to little more than one-third as of the end of 2018, according to data compiled by Bloomberg. A decade before, it was more than 44 per cent. As a result, last year saw US funds "absorbing the largest amount of domestic securities on record," Guillermo Tolosa, an economic adviser to Oxford Economics Ltd. who analyzes global capital flows, wrote in a May 2 note.

"Unregulated" investors, including hedge funds, have taken up much of the supply, Mr Tolosa said. They "tend to be more price sensitive," making Treasuries more vulnerable to things like a spike in inflation.

That could be especially true given where yields are. Wednesday's issue will carry a 2.375 per cent coupon, the lowest in more than a year. Seasonal dynamics could also warrant caution. This month's auction "has a history of going poorly," said Tony Farren, a trader at Academy Securities. In the past decade, the May 10-year has been followed by a sell-off through the next day's close seven times, he said.

"People tend to forecast a little bit of a change, and sometimes it's a huge inflection point which people almost never capture," Mr Dimon said in his warning about being prepared for a game-change move in yields.


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