U.S. Treasury Yields Surge 0.6% as Investors Flee Long-Term Bonds

Anxiety surrounding U.S. assets has intensified, leading to a sell-off in long-term U.S. government bonds and a rise in yields. This unease is particularly evident in the options market, where the premium for protecting against significant losses has reached its highest level since the 2021 "flash crash." The skew in U.S. Treasury options has widened significantly, as investors aggressively push up the prices of put options to hedge against rising yield risks, while call options benefit from the opposite scenario.

This extreme positioning reflects the growing anxiety among many investors, who are losing confidence in U.S. assets due to concerns over the aggressive trade policies of Trump and the increasing pressure he exerted on Federal Reserve Chairman Powell to cut interest rates. These factors, combined with the challenging fiscal outlook, have led traders to demand more compensation for holding long-term U.S. Treasuries, as evidenced by the rising term premium.

Investors have been unwinding positions in recent market turbulence and policy concerns, adding to the upward pressure on yields over the past few trading days. Lawrence Gillum, Chief Fixed Income Strategist at LPL Financial, noted that foreign investors have been selling U.S. dollar assets, exacerbating market volatility. Concerns over the independence of the Federal Reserve and the potential for premature rate cuts have also contributed to the sustained rise in longer-term Treasury yields.

The lack of confidence in the U.S. Treasury market is also evident in the cash market. A weekly customer survey by a major bank showed that neutral positions have risen to their highest level this year. Over the week ending April 21, short positions remained unchanged, while long positions decreased by 5 percentage points, resulting in the fewest fully bullish positions since February.

The situation in the options market could quickly reverse. The severe market disruption in 2021 was short-lived, and a similar scenario could occur if current trade negotiations result in new agreements or if Trump eases his verbal attacks on Powell's leadership of the Federal Reserve. On Tuesday, the U.S. stock market rose, and long-term bond yields fell slightly as traders became optimistic about the possibility of a trade agreement between the White House and major partners, at least for that day.

However, policy changes continue, and uncertainty remains high enough to keep traders on edge. This is also reflected in the U.S. stock market, where options traders are increasingly favoring put options to protect against further declines in the "tech seven" stocks. Ian Lyngen, Managing Director and Head of U.S. Rates Strategy at BMO Capital Markets, expressed skepticism about the easing of the "sell U.S." trade in a report earlier on Tuesday.

In the latest $690 billion auction of 2-year U.S. Treasuries on Tuesday, demand from foreign investors was weak. This was part of the $1.83 trillion total Treasury issuance by the U.S. Treasury Department this week. The final yield on the 2-year Treasury auction was 3.795%, 0.6 basis points higher than the pre-auction yield of 3.789%. This was the largest tail spread since October 2022, indicating that investors are demanding higher compensation to absorb the sale. Notably, indirect bidders, who typically represent foreign central banks and other institutions, accounted for only 56.2% of the allocation, the lowest since the height of the Silicon Valley Bank crisis in March 2023.

The demand from indirect bidders, which was strong just two weeks ago, has now collapsed. If the proportion falls by another 10-20%, the Federal Reserve may have no choice but to restart quantitative easing, becoming the "buyer of last resort" for U.S. Treasuries.