Weak treasury auction flashes more warning lights in the bond market

There were more warning signs in the bond market last week when the U.S. held an auction and the world yawned.

Analysts called the 10-year Treasury auction “soft.” In a nutshell, investors snubbed Uncle Sam, forcing bond yields even higher. In other words, the world is less and less interested in lending the federal government money.

That’s a big problem for a country that depends on borrowers to finance its massive spending problem.

The nuts and bolts of the "weak" treasury auction

A Treasury auction begins with an expected yield, which is essentially the market's forecast for the auction. The “when-issued” interest rate for last week's 10-year Treasury auction was 4.244 percent. 

As it turns out, the final yield was higher – 4.255 percent.

This is known as a “tail.” It means that the government had to sweeten the deal and offer investors a higher yield to entice buyers into the market.

The tail spread is the difference between the highest yield accepted and the "when-issued" (WI) yield right before the auction closes. A large tail signals weak demand, with bidders requiring a higher yield than expected to buy the bonds. This indicates market caution or uncertainty.

This 1.1 basis point tail was the first in about six months.  

In simple terms, the government ended up paying a higher interest rate than anticipated to borrow this $42 billion.

To raise the effective yield, the government sold each Treasury for an average $99.60 instead of $100. As one analyst for the Stock Market News put it, “That might not seem like much, but in the bond world, it screams: ‘Please, just take these.’”

The higher yield wasn’t the only bad sign at this auction. The bid-to-cover ratio was the lowest this year. This metric is calculated by dividing the total number of bids received during the auction by the number of securities offered for sale. This reflects the demand for Treasuries, telling us how many times the offered amount could have been sold based on the bids submitted.

In effect, the federal government wanted to borrow $42 billion. It received $98.7 billion in bids. That compares to $112 billion at the least 10-year auction. As Stock Market News explained, this isn’t just about weak raw numbers.

“It’s about momentum. Investors are getting pickier.”

Foreign buyers were once again notably absent from this auction. Overseas investors bought 64.2 percent of the bonds. That was down from 88 percent in April.

Buying from U.S. investors and mutual funds was also weak. Primary dealers – big banks, including JPMorgan and Citigroup, carried the load in this auction. Here’s the catch – they are legally required to participate.

It’s also notable that the Federal Reserve bought $14.25 billion in bonds. Even though the central bank continues to shrink its balance sheet, it still steps into the market to buy Treasuries to replace those that mature, effectively rolling them over. In other words, even when not running quantitative easing operations,  the Fed still has its thumb on the bond market, creating artificial demand and keeping interest rates lower than they otherwise would be.

One has to wonder how long it will be before the Fed has to more aggressively intervene in the market.

After the auction, the yield on the 10-year on the open market moved up 2 basis points to 4.22 percent. The yield on the 30-year bond also spiked, rising four basis points to 4.813 percent.

Ramifications

This isn’t the first sign of trouble in the Treasury market.

Ebbing demand for U.S. debt is a significant issue for a federal government with an out-of-control borrowing problem.

Bond yields spiked late last year even as the Fed was cutting rates. While the central bank dropped interest rates by 100 basis points, long-term Treasury yields spiked up by over 100 basis points.

At the time, WolfStreet noted, “There are rising concerns in the bond market about the ballooning U.S. debt, and about the flood of new supply of Treasury securities that the government will have to sell in order to fund the out-of-whack deficits. Treasury buyers and holders are spread far and wide, but higher yields may be necessary to reel in the mass of new buyers needed, even as the Fed is shedding its Treasury holdings through QT.”

More concerning is the fact that during several periods of geopolitical instability, Treasuries sold off, indicating that U.S. bonds might be losing their status as a go-to safe haven.

Earlier this year, analyst Artis Shepherd called the situation in the Treasury market “red lights blinking.”

“The bond market is sending a message to the U.S. government that its spending is out of control and the reserve currency ‘privilege’ it has abused for the last 80 years is running out.”

Lower demand for debt means higher borrowing costs for Uncle Sam.

Interest on the national debt cost $144.6 billion in June. That brought the total interest expense for the fiscal year to $921 billion, up 6 percent over the same period in 2024.

So far, in fiscal 2025, the federal government has spent more on interest on the debt than it has on national defense ($682 billion) or Medicare ($723 billion). The only higher spending category is Social Security ($1.18 trillion).

Uncle Sam paid $1.13 trillion in interest expenses in fiscal 2024. It was the first time interest expense had ever eclipsed $1 trillion. Projections are for interest expense to break that record in fiscal 2025.

This is clearly an untenable situation.

I’ve already mentioned that the Federal Reserve is the only player on the field that can significantly shift this momentum. But to do so would require a return to QE and an expanding Fed balance sheet. And that means more inflation.

Shepherd thinks this is the most likely scenario. 

“A rational response to recent events would be for the U.S. government to cut spending, return to a semblance of sound money, and—more generally—begin to scale back the level of its involvement in the lives of everyday Americans. That’s about as likely as the fox guarding the henhouse. More probably—guided by the dominant and ignorant Keynesian model—a new cycle of quantitative easing will arise, forcefully but temporarily driving interest rates down until inflation comes back even stronger. If it continues on this path, the U.S. will dig itself deeper into this hole until it’s buried in it.”

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