50 subject one dollar note sheets sit in a stack before receiving a serial number and the U.S. Treasury and U.S. Federal Reserve seals at the U.S. Bureau of Engraving and Printing in Washington, D.C., U.S. (Photographer: Andrew Harrer/Bloomberg)

Lackluster U.S. Bond Auctions Add to Worries of Foreign Pullback

(Bloomberg) -- For the U.S. to borrow cheaply as it boosts borrowing, it’s going to need overseas investors to step up at its debt auctions. The early indication from this week’s $64 billion slate is that those buyers may be turning skittish.

Whether it’s the ramped-up trade rhetoric, swelling government deficit projections or just yields at the lower end of their recent range, indirect bidders retreated during this week’s auctions. While the data may not be a perfect gauge of foreign interest, BMO Capital Markets strategists say they “suspect it will be made clear that foreign players sat this round out -- or were at least much lighter than normal.”

Lackluster U.S. Bond Auctions Add to Worries of Foreign Pullback

Here’s how indirect bidders shaped up this week:

  • At Tuesday’s $30 billion three-year note auction, they took the smallest share since September
  • At Wednesday’s $21 billion 10-year offering, they purchased the least since November 2016, when the U.S. election roiled Treasuries
  • At Thursday’s $13 billion 30-year sale, they bought 61 percent, the fourth-lowest since the end of 2016, and that result was likely aided by yields rising into the auction

Bond traders have been keenly focused on who’s participating this year because the market is in an unusual situation: the Federal Reserve is raising rates at the same time that the nation’s budget deficit is widening. Without persistent demand from some of the biggest holders of America’s debt, borrowing costs are likely to climb -- meaning investors will see bond prices decline.

‘Strange Bedfellows’

“The growing U.S. deficit coupled with protectionism are very strange bedfellows,” said Andrea DiCenso, a portfolio manager at Loomis Sayles & Co.

A higher deficit forecast “only shows all market participants that we are going to continue to be reliant on foreign investors to participate in our debt markets,” she said. Yet with the Trump administration mulling tariffs, “at what point does that spook the foreign investors in our market? How much do foreign investors put up with” before demanding higher yields, she said.

DiCenso, who’s also a senior strategist in Loomis’s alpha strategies group, says she regularly speaks with the firm’s Treasury desk about money flows, particularly around auctions. Any sign that demand is no longer robust for U.S. debt could reverberate across asset classes, she said.

Lackluster U.S. Bond Auctions Add to Worries of Foreign Pullback

For now, foreign central banks appear content to own Treasuries. The amount of U.S. government bills, notes and bonds held in custody at the New York Fed rose in the week through April 11, after declining three straight weeks from a record $3.1 trillion.

That peak in March coincided with a long-bond auction that indicated plenty of appetite from abroad. Treasury figures show foreign and international investors purchased 19 percent of the U.S.’s $13 billion 30-year bond sale last month, their largest share since 2015. That likely helped the issue draw a yield below what was indicated before the offering.

So far, the fluctuations in demand have had limited repercussions. The benchmark 10-year note yields about 2.83 percent, around the average since the start of February.

But in the face of escalating tension between the U.S. and Russia over Syria, trade friction with China, consensus inflation and a mediocre American labor report -- all of which should support bond bulls -- the question of who’s going to absorb a burgeoning supply of U.S. debt remains a key reason keeping yields range-bound.

©2018 Bloomberg L.P.