Wall Street "Turns Pale at the Mention of 30-Year U.S. Treasuries": Either Avoid Them as Much as Possible or Go Short Directly!

For well-known institutional investors in the US bond market, such as DoubleLine Capital, there seem to be only two attitudes towards 30-year US Treasuries at present: either avoid them as much as possible or short them directly...

Due to concerns about the swelling US government budget deficit and the worsening debt burden, this investment company, led by "new bond king" Gundlach, as well as other well-known fixed-income market investment institutions such as Pacific Investment Management Company (Pimco) and TCW Group Inc., have adopted similar strategies: avoiding the longest-dated US government bonds and instead favouring shorter-term bonds with lower interest rate risks that still offer considerable returns.

As government spending has increased globally—from Japan to the UK and then to the US—confidence in long-term bonds has been eroded. This portfolio adjustment, shifting from long-term to short-term bonds, has performed well this year. Last month, following S&P and Fitch, Moody's, the last of the world's three major rating agencies, also stripped the US of its Aaa sovereign credit rating.

In fact, from the perspective of the yield curve structure of US Treasuries, the steepening of the yield curve this year has become particularly evident—the yield on 30-year US Treasuries has continued to climb sharply, while the yields on medium- and short-term Treasuries, such as 2-year and 5-year notes, have instead declined.

As investors worry about the possibility of the US government issuing more bonds to cover the deficit, the yield on 30-year US Treasuries reached 5.15% last month, approaching its highest level since 2007. Meanwhile, the spread between the yield on 30-year US Treasuries and that on 5-year US Treasuries rose above 100 basis points for the first time since 2021.

This discrepancy is extremely rare—the last time it occurred throughout the year was in 2001, undoubtedly highlighting the pressure on long-term bonds, as investors demand additional compensation to be willing to lend to the US government for such a long period. The decline in long-term bonds has been so severe that some have even begun to speculate that the US Treasury Department may reduce or halt the auction of the longest-dated bonds.

Avoiding long-term bonds,

Richard McGuire, a strategist at Rabobank, said, "We can certainly see why the long end of the US Treasury curve is unpopular. The US policy outlook is too bleak to attract buyers of long-term US Treasuries."

Bill Campbell, a portfolio manager at DoubleLine Capital, pointed out, "When we can short directly, we are betting on the steepening of the yield curve, expecting long-term yields to rise relative to short-term yields. In other purely long-only strategies, we are essentially staging a 'buyer's strike' and instead investing more in the middle part of the yield curve.""

In fact, the US fiscal situation had already prompted Pimco to call for caution on 30-year Treasuries as early as the end of last year, and the firm still maintains an underweight position on long-term bonds.

Mohit Mittal, chief investment officer of core strategies at the bond giant, said Pimco currently favours the 5-year and 10-year segments of the US Treasury yield curve and is looking at non-US bonds. "If there is a rebound in the bond market, we believe it will be led by the 5-year to 10-year segment, not long-term bonds," Mittal said.

Given that the US Treasury has long sought stability in its debt auction schedule, the growing chatter on Wall Street about scaling back 30-year Treasury auctions seems unusual.Bob Michele, global head of fixed income at JPMorgan Asset Management, said last week,that long-term bonds are not currently trading as the risk-free assets that Wall Street has long considered them to be, and that the possibility of scaling back or cancelling auctions is real.

"I don't want to be the guy standing in front of the steamroller right now," Michele said in an interview. "I'll let others help stabilise the long end. I'm worried things will get worse before they get better."

TD Securities strategists, in a report last week, forecast that the US Treasury could signal a move to scale back long-end auctions as early as in its August refinancing announcement.

However, a US Treasury spokesperson recently said that auction demand for bonds of all maturities has been strong, and the government will adhere to its long-standing policy of issuing bonds in a "regular and predictable manner." In a statement on April 30, the US Treasury also pledged to keep auction sizes for long-term bonds and other maturities stable—at least for the next few quarters.

Looking ahead, it is foreseeable that a key test will come on June 12, when the next 30-year Treasury auction takes place.

Long-term bond auctions in major economies have recently become a significant "storm centre" for global markets. In Japan last month, long-term bond auctions showed worrying signs of weakening confidence in the country's longest-dated bonds, with demand for a 40-year Japanese government bond issue hitting its weakest level since last July, increasing pressure on officials to reduce issuance of such long-term bonds. Similarly, the auction results for 20-year US Treasuries in the US last month were also sluggish, further exacerbating concerns about demand for long-term US Treasuries.