Authored by Simon White, Bloomberg macro strategist,
The Treasury rally saw an abrupt turnaround on Thursday, with yields climbing over 15 bps. This came on the back of overbought conditions in bonds and stocks, with the S&P dropping 0.8%. The curve ball came in the 30-year auction, having the worst tail in over 10 years. This will exacerbate already-poor liquidity conditions in the Treasury market, and mean rallies are unlikely to be sustained for long.
Treasury auctions normally don’t make much news, but Thursday’s 30-year sale saw the worst tail (median – high yield) since August 2011, when the S&P downgraded the US from its AAA rating. Primary dealers, who backstop auctions, had to take a quarter of the issue, double the proportion they take on average.
Ever-larger government issuance and the Federal Reserve’s hiking cycle have amplified fixed-income volatility.
As the chart below shows, high fixed-income vol goes hand in hand with worsening liquidity in the Treasury market. Bloomberg’s US Treasury Liquidity Index compares yields to a fitted curve; the greater the gap between actual versus fitted values, the worse liquidity is likely to be.
Worsening liquidity increases the possibility of future weak auctions – one of the reasons investors like Treasuries is that they are “safe,” and stable. As their volatility rises and liquidity falls, they will become less attractive. Moreover, their utility to multi-asset investors as a portfolio and a recession hedge when the stock-bond correlation is positive will wane, reducing demand further.
[ZH: As we detailed yesterday, the powers that be already had an excuse ready for the dismal 30Y auction and the dismal-er liquidity situation in Treasuries.]
As The FT reported that a ransomware attack on the Industrial and Commercial Bank of China has disrupted the US Treasury market, according to market participants.
The attack prevented ICBC from settling Treasury trades on behalf of other market participants, according to traders and banks.
“This is a large party on [the Fixed Income Clearing Corporation], so certainly of major concern,” said an executive at a large bank that clears US Treasuries.
“And potentially impacting liquidity of US Treasuries.”
ICBC was starting to restore services as of Thursday afternoon, according to some of the people briefed on the incident.
The problem is - for this narrative - that Treasury liquidity worsened this afternoon - AFTER ICBC was back...
[ZH: This 'excuse' is even more problematic...]
So the US Treasury market was allegedly crippled by a hack of China's largest bank.— zerohedge (@zerohedge) November 10, 2023
Isn't the bigger story here that a Chinese bank can paralyze the $75 trillion US bond market?
The increasingly poor backdrop for Treasuries means the chance of an auction failure, in the sense the bid-to-cover ratio comes in under one, is now non-negligible.
All of this makes it more likely Treasury Secretary Janet Yellen continues to keep funding skewed towards bills for longer.
Overall, Treasuries will continue to face more downside than upside risk, especially as the chance of a near-term recession has receded.