A Brief Postscript on the Debt Ceiling Fear Morph

Typical of a young bull market, the debt ceiling’s resolution last week didn’t cause fear to vanish. Rather, the worries just morphed from “default” (a false fear through and through, in our view) to a sudden supply surge flooding the market—sending Treasury bond prices down and long-term rates up. We tip our hat—to a degree—for the focus on supply and demand. Those twin forces move bond prices yet are often absent from discussion. However, we don’t think the fear holds up, and markets don’t seem to buy it, either.

This is admittedly a very small window, but 10-year Treasury yields are actually down since House Speaker Kevin McCarthy and President Joe Biden reached the debt ceiling deal over Memorial Day weekend. The Friday before the long weekend, the 10-year closed at 3.82%.^[i] As we write on Tuesday afternoon, it is down to 3.67%.^[ii] Short-term moves are virtually impossible to decode, given they stem primarily from sentiment and short-term traders. But we also think it is fair to say that if investors anticipated a market-distorting supply increase, bonds would pre-price it, and rates wouldn’t have fallen.

A quick look at Treasury auctions backs this up. It is early days, so we have had just two T-bill auctions since the deal was signed—no longer-term bonds. But they are a helpful early test of whether demand exists to soak up supply, and the results are very, very encouraging on that front. The Treasury auctioned a tranche of three-month bills and a tranche of six-month bills Monday. The three-month offering was massively oversubscribed: The Treasury received over $204 billion worth of bids for just over $65 billion worth of bills at a median interest rate of 5.18%.^[iii] That is a shade below the rate available on the secondary market. The six-month bill was almost as popular, fetching nearly $182 billion worth of bids for just under $58 billion worth of supply at a median 5.2%.^[iv] This, too, is below the secondary-market rate. Bid-to-cover ratios of 3.15 and 3.14 in the two respective auctions, with bills sold at a slight premium, isn’t what you would expect if supply were overwhelming demand.^[v]

If anything, it is the opposite, which we think makes sense. Think back longer than a week, and it becomes readily apparent that supply was static for nearly half a year. Frozen in place, with new bonds issued only to replace maturing ones. During that span, rates were volatile but eventually sank below pre-debt ceiling levels (before the standoff heightened fears later in the spring), suggesting demand was plenty solid. The Treasury can finally start meeting this higher demand, giving eager buyers more of what they want. Normal, healthy market functioning can resume.

All that has really happened is that the debt ceiling fracas back-end-loaded 2023’s Treasury issuance. People can debate whether this is optimal, but we don’t think it changes the overall forces at work. Treasury supply will rise, just as it has in years past, satisfying the never-ending queue of people and institutions who want to buy them. That people fear this very normal thing is a good sign the pessimism of disbelief still runs rampant—a classic new bull market backdrop.