Treasury Auctions: Who Cares? You Should. A Primer

There are many different ways to sell things: a lemonade stand, a flea market, through Target, or at an auction, to name but a few. Lenders sell their loans through a variety of ways, and they tend to go to the highest bidder who offers minimal hurdles. U.S. Treasury auctions aren't all that different from any other public or private auction, but selling newly issued Treasury bill, note, or bond typically involves billions of dollars and can move world markets. Securities are purchased at a certain price, which determines the yield, which helps determine the rates of other securities… like securities backed by mortgages.

To take a step back, many companies issue stock or offer debt to investors. The United States, however, has used only debt to help pay for the services it provides since the country was founded. The government still offers a range of securities nearly weekly, such as Treasury bonds, notes, and bills, also known as T-bonds, T-notes, and T-bills. They vary by factors like the duration of the contract, the size of the offering, and the amount of interest they pay. That last part is important because it determines the return, or yield, an investor gets every year.

Each quarter, the U.S. Treasury department releases refunding announcements estimating how much debt will be auctioned in the next two quarters and how that debt will be split into various maturities. Everyday investors, institutional investors (such as banks), and central banks of foreign countries typically buy them, as anyone can bid for Treasuries through a TreasuryDirect account or through a bank, broker, or dealer.

Just as investors in MBS watch application data and security issuance, Treasury investors watch the supply. If the Treasury forecasts it needs to issue more debt than expected, it can cause yields to climb as prices drop so that it can all be sold. The Treasury holds nearly 300 auctions each year and sells more than $8.3 trillion worth of securities. Interest rates are set based on the auction results, which affects the prices people, banks, and brokers pay the Treasury for the security. These yields, based on supply and demand, help determine mortgage rates.

Mortgages rates follow T-note and T-bonds, not bank rates. Remember that the Federal Reserve controls the rates at which banks loan money to each other overnight, known as the fed funds rate. But mortgages have a much longer lifespan, and as a result they most closely track 5-year or 10-year U.S. Treasury notes, debt issued by the U.S. government and traded by investors in the bond market. And the prices of those are based on investor expectations.

If investors expect inflation to be higher, for example, investors will want higher yields so their investments don't lose value. It’s also the case that when inflation goes higher, the risk that interest-paying investments will lose value makes their prices decline. Bond prices decline when yields rise, and vice versa.

We are asked, “Why are mortgage rates higher than bond yields?” While mortgages go in the same direction as the bond market, there is still a big “spread,” or difference between the two. Currently 30-year fixed-rate mortgages are 6.75-7.25, whereas the yield on the 10-year risk free Treasury note is around 4.60.

Mortgages are much riskier investments than debt issued by the government of the largest economy in the world. Individual homeowners can and do default regularly. Mortgages are also riskier because homeowners have the ability to refinance whenever they want, for any reason, with no penalty. Investors and institutions that buy mortgages and mortgage bonds have no guarantee that they’ll be able to count on constant cash flows from those financial products, so they demand more yield (and lower prices) to buy them.

But mortgage rates aren’t even staying the same. They’re rising. In short, that's because inflation is still an issue, the economy is doing well, and risks are rising. The monthly cash flow of borrowers has worsened with many seeing higher insurance costs. The U.S. Fed has made significant progress in taming runaway inflation, but finally touching its 2% target will be hard. Policymakers acknowledged as much a few weeks ago when they forecast fewer rate cuts in 2025 than previously expected. "Inflation has been moving sideways," Fed Chair Jerome Powell said at a news conference, adding that achieving the goal of 2% inflation has "kind of fallen apart as we approach the end of the year."

There’s little reason to expect the bond market to pick up, e.g., prices to go up, and rates go down. There is concern about the debt and the deficit, but also, we are in an environment where economic growth is looking like it's going to remain stronger. And that requires a higher natural rate of natural interest rates.

Mortgages, meanwhile, have their own concerns: with rates for home loans having been so elevated for such an extended period over the past two years, investors have every reason to expect more prepayment risk than usual. No one wants an 8 percent mortgage if they can refi and obtain 6.75. (On top of this, insurance and property tax bills are now greater than mortgage payments for many homeowners. But that is a story for another day.)