In the next two days, two auctions will have an impact on the direction of "global major asset" market.

Long-term US Treasury bonds will face another "hardcore test" this week, as concerns about weak demand for government bonds begin to spread. Wall Street believes that if demand remains "abysmal," the US stock and bond markets may once again face a "major sell-off."

On Monday local time, the US Treasury will conduct a $37 billion auction of 10-year government bonds, followed by a $21 billion auction of 30-year government bonds on Tuesday. The supply pressure caused by large-scale issuance of bonds has exacerbated concerns in the market about the imbalance between supply and demand for US bonds this week.

Last Friday, the unexpected strength of the non-farm payroll report dampened expectations of interest rate cuts, causing US bond yields to rise by more than 10 basis points. The yield on 10-year government bonds moved away from a three-month low, and the yield on two-year bonds reached a new high for the month. Is the recent upward trend in US bonds reversing?

It is widely believed that the "flood" of US long-term bonds has far exceeded market demand, and the two important auctions this week may once again plunge the previously rebounding US bond market into a "vortex of pain."

Deutsche Bank stated in its latest Global Economic Risk Report that after two years of pressure from the US fiscal deficit, the US government debt ceiling crisis, and regional banking storms, will there still be a large number of investors willing to buy US bonds? This may be one of the major market risks that Wall Street will face next.

BlackRock stated in a report released on December 11th that the market's bet on interest rate cuts by the Federal Reserve may be in vain, and volatility in the US financial market will intensify by 2024. It recommends selling long-term US government bonds.

Why is Wall Street so nervous?

This cannot be mentioned without referring to the huge impact caused by the dismal performance of the US 30-year government bond auction last month.

On November 9th, the US Treasury auctioned $24 billion of 30-year government bonds, which was described as a "complete disaster" due to the dismal demand. Various demand indicators performed poorly, and overseas demand significantly declined.

Wall Street News previously mentioned that the data that Wall Street is most concerned about is the spread between the expected yield of 30-year US bonds and the winning bid rate, also known as the "tail." The higher the tail of the auction, it means that the issuer of government bonds must attract investors to buy bonds at a price higher than the market interest rate, which indicates weak actual demand for the bonds.

During the auction last month, the expected yield of 30-year US bonds was 4.716%, which resulted in a 5.3 basis point "tail," the largest tail spread since data records began in 2016. Moreover, all demand indicators were poor. The bid-to-cover ratio for the 30-year bond auction was 2.24, weaker than the previous 2.35 and lower than the average ratio of 2.44 for the past six auctions, reaching the lowest level since December 2021. The market quickly reacted to the auction results, with US stocks and bonds suffering heavy losses, and the 30-year US Treasury yield experiencing its largest single-day increase since March 2020.

Wall Street believes that the fundamental problem of severe imbalance between supply and demand for long-term US bonds remains serious and unresolved. The Federal Reserve is still implementing quantitative tightening policies, and the private sector is unable to absorb the massive amount of bonds. Concerns about the oversupply of long-term bonds in the market may affect investment portfolios and market stability:

Primary dealers (banks that purchase bonds at auctions and then make a market for them) are key players in the US Treasury issuance system. With the surge in debt issuance, they are buying more US bonds than they can sell, causing the yield on 10-year or longer-term US bonds to rise above the swap rate (i.e., narrowing the swap spread).

However, dealers were originally hedging bond price risks through swap transactions and profiting from the interest rate differential between the two. As a result, primary dealers have no reason to hold a large amount of US bonds.

Is the US Treasury still issuing bonds?

In the face of weak demand, the sensitivity of long-term bond yields to supply and demand is increasing. In November, the US Treasury announced a slowdown in its fourth-quarter borrowing plan, but stated that future bond issuance would increase:

Based on projected medium- and long-term borrowing needs, the plan is to "gradually" increase the size of most bond auctions from November 2023 to January 2024, and it is expected that an additional quarter's size will be needed after that to meet its financing needs.

As shown in the chart below, after a slight decline in the size of long-term bond issuance in 2022, the issuance volume is once again rising and is likely to continue indefinitely. Looking ahead, the total amount of US bond issuance will be enormous, and according to the Congressional Budget Office's (CBO) projections, the proportion of US bonds to US GDP may climb from the current 120% to 200% in the long term.

The US Treasury released a report last week stating that the federal government's fiscal deficit for the 2023 fiscal year is nearly $1.7 trillion, an increase of $320 billion compared to the previous fiscal year, representing a 23% year-on-year increase. The average annual percentage of the federal government's budget deficit as a share of GDP over the past 40 years has been 3.7%, but in 2023, it will rise to 5.3%, reaching the third-highest level in US history.

And this may just be the beginning, as interest rates continue to rise, the annual interest on national debt will soon exceed $20 trillion. The Congressional Budget Office (CBO) estimates in a report released on December 4th that the cumulative budget deficit over the next decade will reach approximately $20 trillion.

Some analysis points out that next year, the increasing downward pressure on the US economy will lead to a decrease in fiscal revenue and an increase in fiscal expenditure, which will also increase the debt pressure and future debt risk of the United States:

The revenue of the US federal government is cyclical, while fiscal expenditure tends to be countercyclical to smooth out the fluctuations in the US economy. With the expectation of further economic slowdown or even recession next year, it is expected that US employment will further weaken, and fiscal revenue may continue to decline, while US fiscal expenditure will remain at a high level. Therefore, the US debt stock will further accumulate, coupled with the high interest rate environment, and the future fiscal risk of the United States will further increase.

Ray Dalio, the founder of Bridgewater Associates, warned in a report released on December 2nd that now, no matter how the US Treasury sells US bonds or what monetary policy the Federal Reserve adopts, it is unlikely to solve the problems currently faced by US bonds in a substantial way, because the "big problem of US debt and inflation" will eventually lead to the collapse of US bonds.