The Last Time We Had A Week Like This, US Government Borrowing Costs Surged

A rare occurrence in the U.S. government bond market last week could be signaling a big upward move in yields is on the way.

Last week, three consecutive Treasury auctions, involving 3-year, 10-year, and 30-year bonds, “tailed”–in other words, the bonds all ended up trading at higher yields than markets were pricing before the auction–indicating weakening investor demand for Treasury bonds after a big rally over the past few months.

Morgan Stanley head of U.S. interest rate strategy Matthew Hornbach wrote in a note to clients that “a week to remember is in the history books,” given that three Treasury auctions tailing in a row like they did last week–which Hornbach calls a “hat trick tail”–doesn’t happen very often.

When the hat trick tail does happen, however, it can be a precursor to a significant correction in the bond market. Here is a table of what happened to Treasury yields after the last couple of “hat trick tail” occurrences:

Hat trick tails

Photo: Morgan Stanley

The biggest correction in Treasuries that sent yields highest was the last hat trick tail, which happened in October of 2010. Hornbach writes that this time, we could see similar results:

From a timing perspective, the hat trick that occurred this week most closely resembles the hat trick that occurred in October 2010. Not only did they both occur in the second half of the year (but well before year-end), they also occurred after a significant bond market rally. Event-driven analysis should consider such an occurrence noteworthy, and given the current levels of yields, it might make sense to hedge exposure to higher yields over the next month.

Here is a chart illustrating the massive spike in yields after the most recent hat trick tail occurred in October 2010:

Hat trick tails

Photo: Morgan Stanley

Hornbach also noted that August tends to be a good month for Treasuries, so if anything, the two opposing forces are “likely to keep actual volatility higher than what we witnessed over the past several months.”

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