The Treasury Department’s latest 3-year note auction revealed significant market strain, with the sale producing one of the largest “tails” – the gap between the expected and actual yield – in recorded history. The auction’s tail of 2.4 basis points was surpassed only by two previous occasions: during the COVID-19 crisis and the Silicon Valley Bank collapse in 2023.
The $58 billion offering settled at a yield of 3.784%, marking a decrease from the previous month’s 3.908% but significantly exceeding the when-issued yield of 3.760%. The bid-to-cover ratio, which indicates overall demand, declined to 2.47 from 2.70 in the prior auction, reaching its lowest point since October.
While market participants were closely monitoring potential signs of Chinese divestment from U.S. Treasuries, the auction results painted a more complex picture. Foreign participation, represented by indirect bidders, actually increased to 73.0% from 62.5%, representing one of the highest levels on record. However, the auction’s weakness stemmed from an unexpected source – domestic direct bidders, whose
participation plummeted to just 6.2% from 26.0% in the previous month, marking one of the lowest direct bid rates ever recorded.
The dramatic decline in direct bidder participation offset the strong showing from foreign buyers, who accepted $42.2 billion of the $57.8 billion available after accounting for Federal Reserve holdings. This stark contrast in bidding patterns suggests a significant shift in domestic appetite for U.S. government debt, even as international demand remains robust.
The poor auction results raise continued questions about the sustainability of financing the U.S. budget deficit, particularly given the heavy reliance on foreign buyers. While international participation remained strong in this auction, the dramatic pullback by domestic investors signals potential underlying stress in the Treasury market.
The historically wide tail, combined with the collapse in direct bidder participation, places this auction among the most problematic in recent years. Only the market disruptions during the initial COVID-19 crisis and the banking sector turmoil surrounding SVB’s failure produced worse results in terms of pricing outcomes.
This development comes at a crucial time for U.S. debt markets, as the Treasury continues to fund substantial government spending through regular debt issuance. The stark contrast between foreign and domestic participation patterns suggests a potential divergence in how different investor classes view U.S. government debt at current yield levels.
While the maintenance of strong foreign demand provides some reassurance about the market’s ability to absorb new Treasury issuance, the dramatic withdrawal of domestic direct bidders raises concerns about market dynamics and the potential for future
instability in government debt markets.
The question of how long foreign investors will continue to
demonstrate such robust demand for U.S. Treasury securities remains paramount, especially given the significant role they play in financing American government spending. The sustainability of this funding model could face increasing scrutiny if domestic participation continues to show weakness in future auctions.
This auction’s results highlight the ongoing challenges in the U.S. Treasury market, where strong foreign demand currently masks concerning weakness in domestic participation. The ultimate
implications of this divergence may become increasingly important for market stability and government funding costs in the months ahead.