Why a 7-Year Treasury Auction Suddenly Matters

Dow Jones
09/25

The relentless climb in bond yields has turned routine market operations into the talk of the town.

The benchmark 10-year yield is hovering around highs not seen in 19 years. When the yield on 10-year Treasury debt rises, mortgage, credit card and other rates in the economy can follow, squeezing wallets and pressuring the housing market. A confluence of factors is pulling up 10-year yields, including the tidal wave of bond supply investors are asked to gobble up.

The latest test came in the form of a U.S. government debt auction that expires in seven years. The Treasury Department routinely sells debt to fund the government's spending in excess of its revenue. Typically, no one cares about a 7-year auction. It lacks the structural demand a 10-year has, and since it goes to the block after the 5-year note, investors already have a clear read on the market's appetite for medium-term debt.

Yet, Thursday afternoon's auction got an unusual spotlight. Blame in part rests with the 5-year auction on Wednesday, which was the second worst 5-year auction over the past 15 years.

"There are risks that today's 7y auction could also go poorly," wrote Citi strategist Jason Williams. "Historically, the weakest 7y auctions tend to occur after a poor 2y and 5y auction."

The auction was indeed weak. Investors achieved 5.085% in yield, the highest since the note was reintroduced in February 2009. The yield was almost 0.01 percentage points higher than the level indicated just before the bidding deadline, suggesting investors demanded a higher yield to buy the debt.

That led to a further selloff in bonds. The yield on seven-year notes rose to 5.107%, near its session high. Yields on 10- and 30-year yields inched higher to levels not seen since 2007 and 2004, respectively. (When bond prices fall, yields rise.)

The rise in bond yields has been relentless, and anyone investing in Treasury auctions has to contend with that momentum. Earning more income from higher yields at auctions doesn't eliminate the risk of bond prices falling during the duration of the bond. That can eat into total returns-and explains why investors are demanding an even bigger payout to participate. In a testimony before Congress on Sept. 15, Treasury Secretary Scott Bessent boasted about demand at prior Treasury auctions. But that demand is not guaranteed, especially as the government now competes with an influx of corporate bonds.

Lately corporations with riskier debt are willing to step up with juicier yields to win capital. Global investment company SoftBank Group recently raised a record amount of cash from junk bond investors and in return offered a 9.75% interest rate on a bond that expires in 7.5 years, per a company statement. The lowest potential yield on distressed corporate debt has climbed to nearly 16%, reaching its highest mark since November 2022.

Banks, hedge funds and other institutions routinely weigh the risk of a borrower defaulting against the return it can potentially offer-and that payout is looking attractive for investors with the risk appetite and space on their balance sheets.

How much more do Treasuries have to offer?

 

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