The 3rd Quarter Interest Rate Test

The 2nd Quarter Interest Rate Correction

The following monthly chart of the 10-year U.S. Treasury bond (SPTL) reveals that the 2nd quarter decline in interest rates was really just a correction in an ongoing, longer term move higher:


Many investors have been scratching their heads over this move lower in yields given Consumer Price Index (CPI) inflation is running 5% and oil prices have continued to move higher. The picture becomes clear when you look at the U.S. Treasury market supply & demand fundamentals.

There are six factors at play here that explain the 2nd quarter decline in longer term interest rates.

  1. The U.S. Treasury sold a large amount of bonds in March above and beyond what was already required to cover the structural budget deficit—roughly $342 billion by my estimate. This explains the peak in the 10-year bond yield in mid-March. The Treasury got a lot of additional needed borrowing out of the way before the 2nd quarter.

  2. The U.S. Treasury exited the 1st quarter with $1.1 billion in its bank account at the Federal Reserve (Treasury General Account). On June 30th it was $852 billion. The Treasury thus had $250 billion of additional funds from drawing down this account.

  3. U.S. Commercial banks continued their heavy buying in the 2nd quarter to the tune of $301 billion.

  4. Foreigners started buying again in April (+$42 billion) after being net sellers in March (-$71 billion). Foreigners have not been net buyers of Treasuries since July 2020 so this is an interesting development. May and June data is not out yet, but I expect that we are going to see further upticks in foreign buying.

  5. The U.S. Government still has a lot of spending to do to fund the commitments made in recent spending bills and this means that there is still a lot of borrowing to do—$2.3 billion at the end of May by my estimates.

  6. The Federal Reserve continues to buy $80 billion of U.S. Treasuries per month.

I estimate that the Treasury only had to sell $141 billion in net new Treasuries during the 2nd Quarter. When you run the numbers, you can see that there were simply a lot more buyers than sellers. This rosy scenario ends in the 3rd quarter. A test is coming.

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The information presented in the True Vine Letter is general in nature and designed for do-it-yourself and professional investors. It does not have regard to the investment objectives, financial ...

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