A “Solid” Treasury Auction Shows How Screwed Up this Market Is

The US Treasury was happy today because it sold a bunch of 2 year notes for a just slightly higher than planned on interest rate, with decent demand characteristics.  If you read recent posts on Treasury debt issuance, you knows that longer term auctions have struggled, unless they are relatively small in size.  This two-year auction was mammoth–$66 billion, the largest two-year auction ever.  Why is the US Treasury issuing so much two-year debt, which actually carries a higher interest rate than some longer term issues?  Because no way in hell could it sell $66 billion in ten year or 20 year or 30 year debt, without a disaster of an auction–weak demand and much higher rates.

The estimable Wall Street Journal says the negative term premium shows the Treasury market isn’t in distress, but that is just wrong-headed thinking derived from a time from the US wasn’t running huge deficits every year and didn’t have a debt that was far larger than GDP.  Those two-year note buyers aren’t stupid, they know that they are getting a higher interest rate now and that in two-years when the government has to issue more debt to repay these notes, it will almost certainly be paying a rate as high or higher, whether on a short-term or long-term debt issue.  Since the government can’t sell this much long-term debt, it has to use short-term instruments and pay a higher interest rate.  So the dynamics of the Treasury market are actually very weak and should be a warning to a sane Congress to cut spending right now.

It is a stupid strategy for the Treasury to issue so much short-term debt that just has to rollover sooner at a ongoing higher rate.  Do that five times and you paid more in interest than if you just sold it as a ten-year issue, except that you know you can’t sell $66 billion in ten year notes.  And hoping the Federal Reserve is going to bail you out by buying the debt isn’t a sound strategy either.  The Fed hoovering up US debt just delays the inevitable by a very short time and causes problems of its own.