The demand for debt issued by the U.S. federal government has been plunging despite rising yields, and this is a worrisome sign to some observers. During 2018, the U.S. Treasury issued notes and bonds worth $2.4 trillion, but the bid-to-cover ratio, which compares the value of bids received to the value of debt actually sold in Treasury auctions, was at its lowest since the financial crisis year of 2008, per data from Bloomberg reported by Business Insider (see below). "All financial crises begin with a declining bid-to-cover ratio," warns Torsten Slok, the chief international economist at Deutsche Bank.
A Flashing Warning Light
- In 2018, bids for U.S. bonds were only 2.6 times the value of those offered
- Lowest demand since 2008
- Down from a recent peak of 4.0 times in late 2012
- May make it harder for U.S. to finance its growing federal deficit
Source: Bloomberg, as reported by Business Insider
Significance For Investors
Given that the yield on the benchmark 10-Year U.S. Treasury Note had reached its highest level since 2011, the diminishing bid-to-cover ratio suggests declining confidence in the obligations of the U.S. federal government as a virtually risk-free safe haven for investors. This is especially troublesome in the face of rapidly increasing budget deficits for the U.S.
"All financial crises begin with a declining bid-to-cover ratio." -- Torsten Slok, chief international economist, Deutsche Bank
In its most recent fiscal year, which ended on Sept. 30, the federal deficit was $779 billion, up by 17% from the prior fiscal year, per The New York Times. Projections from the Trump administration and outside analysts indicate that it will swell to $1 trillion by fiscal year 2020, which ends just prior to the next presidential election, the same report indicates. Rising spending combined with tax cuts are producing the widening gap.
Meanwhile, the record high debt loads at U.S. corporations have been cited by HSBC, a leading multinational bank, as a key risk for 2019. Similarly, research firm CLSA also finds the massive issuance of corporate debt in recent years as contributing to a buildup of excess leverage that eventually may spark a sudden collapse in asset prices, per BI.
The declining bid-to-cover ratio for U.S. federal debt may be another manifestation of plunging liquidity in the financial markets. A sharp contraction in liquidity marked the early stages of the 2008 financial crisis, according to a report from Deutsche Bank, which sees parallels today.
A more optimistic view has been advanced by Mohamed El-Erian, chief economic advisor at German-based insurance and investment management firm Allianz SE. "This concept that a slowdown in the U.S. means a recession or means a financial crisis--that's just wrong," he told CNBC. "What happened in 2008 was very special. It's because the banking system was at risk. And the minute you put the banking system at risk, you put the payments and settlement system at risk. We're not there," he elaborated.
Falling liquidity, including falling demand for supposedly safe-haven assets such as U.S. federal government debt, is especially worrisome as the supply of debt, both public and private, has been soaring. It is unclear whether the markets and the economy can withstand the pressures if these trends continue.