Insights into this week's US Treasury auctions: 20-year U.S. Treasury bonds and 30-year TIPS.

Summary:

• Expectations for This Week's 20-Year Bonds and 30-Year TIPS Auctions: The 20-year bond auction is expected to see weak demand due to offering the lowest yield in eight months, political uncertainties, and lower liquidity. In contrast, the 30-year TIPS auction is likely to attract more balanced interest, driven by attractive real yields and expectations for elevated long-term inflation.
• Significance of Demand at the 20-Year Bond Auction: The demand at the 20-year bond auction will be crucial for assessing investors' appetite for longer durations, particularly after the recent tepid interest in the 10- and 30-year U.S. Treasury auction. Tepid demand might be a sign that markets are not willing to extend duration amid macroeconomic and political uncertainties.
• Impact on Bond Markets: This week’s Treasury auctions are unlikely to cause significant price swings ahead of Powell’s Jackson Hole speech, as markets await clarity on potential rate cuts. Ten-year yields, currently around 3.9%, could retest recent lows if they break below the 3.8% support level.

Anticipated Market Dynamics: Weak 20-Year Treasury Auction Expected, 30-Year TIPS Auction to Reveal Investor Sentiment on Economic Outlook

The U.S. Treasury is set to auction $24 billion in coupon-bearing Treasuries this week, divided between 20-year Treasury bonds and 30-year Treasury Inflation-Protected Securities (TIPS). Recent auctions of 10-year and 30-year Treasuries in July have seen a decline in direct bidders, despite $150 billion in 3-year and 10-year notes maturing earlier this month. While the typical summer slowdown in liquidity may partly explain the sharp drop in direct demand, it's worth noting that primary markets have been particularly active, with $83 billion in investment-grade corporate bonds issued since the start of the month—a 20% increase from the same period last year. This surge in corporate issuance may have led investors to prioritize these deals over U.S. Treasury offerings, potentially diverting demand away from government bonds.

An additional $125 billion in 2-, 5-, and 7-year U.S. Treasury notes are set to mature by the end of the month, potentially boosting demand for next week’s issuances of similar maturities. However, uncertainty remains about whether investors will extend their portfolios' maturity at this week's 20-year auction, despite these bonds offering roughly 40 basis points more than 10-year Treasuries and 11 basis points more than 30-year bonds. The 20-year bond’s lower liquidity and lack of benchmark status compared to 10- and 30-year bonds make it generally less attractive to traders and investors. Additionally, it sits poorly on the yield curve, offering neither the ultra-long duration of the 30-year bonds nor the shorter duration and benchmark status of 10-year bonds. Additionally, the bonds might not be attractive even for foreign investors as currency hedged 20-year Treasuries are less appealing compared to European and Japanese sovereign alternatives.

Investors may also be closely monitoring political developments this week, particularly with Vice President Kamala Harris having just released her economic plan and set to speak at the Democratic National Committee (DNC) on Thursday. Early indications suggest that fiscal spending is unlikely to decrease post-Biden, and the populist policies proposed by both democratic and republican candidates could sustain inflationary pressures at elevated levels for an extended period. This outlook may prompt investors to avoid duration risk, especially when that risk is associated with less liquid segments of the yield curve.

Demand at the upcoming 30-year TIPS auction will also be closely watched, as strong interest could signal concerns that inflation may stay elevated over the long term. The yield on the 30-year TIPS is currently around 2%, which is still one the highest in over fifteen years, offering substantial inflation protection in the event of future price increases. However, it's important to consider that if investors anticipate a significant economic slowdown and an aggressive interest rate cutting cycle by the Federal Reserve, they might avoid this auction. In such a scenario, nominal long-term Treasuries would be a more attractive option.

Bond Market Impact: Yields Likely to Stay Rangebound Ahead of Powell's Jackson Hole Speech.

This week’s Treasury auctions come at a critical juncture for bond markets. Several Federal Reserve officials have signaled a willingness to consider rate cuts at the September FOMC meeting, with bond futures pricing in the possibility of a 33 basis point cut next month and up to 100 basis points in cuts by the end of the year. Markets are eagerly awaiting Powell’s speech at Jackson Hole on Friday to gauge whether a larger 50 basis point rate cut might be on the table. As a result, even if the 20-year U.S. Treasury auction performs better or worse than expected, significant price swings are unlikely ahead of Powell’s remarks.

Ten-year yields have risen from their August 5th low of 3.66% to around 3.9%. If yields break below the 3.8% support level, they could potentially retest their recent lows.