On the eve of the Federal Reserve decision, the 20-year U.S. Treasury auction was impressive, and mortgage rates fell to a three-year low.

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On the eve of the Federal Reserve's interest rate decision, on Tuesday local time, the U.S. Treasury auctioned 20-year Treasury bonds. The auction results showed very strong demand, with the allocation ratio to direct bidders, which represents domestic U.S. demand, hitting a record high. On the same day, U.S. mortgage rates dropped sharply, as investors in mortgage-backed securities appeared to be positioning themselves ahead of the widely expected Fed rate cut.

20-year U.S. Treasury Auction

The winning yield for this 20-year Treasury auction was 4.613%, a significant decline from 4.876% at last month's auction, the lowest level since October 2024. The yield was 0.2 basis points below the pre-auction yield of 4.615%, marking the third consecutive time it was "below pre-auction yield".

The bid-to-cover ratio for this auction was 2.74, higher than July’s 2.54 and the second-highest since March, also above the recent six-auction average of 2.65.

The market is most focused on the internal auction data:

The indirect bid ratio was 64.6%, higher than last month’s 60.6%. Indirect bidders usually include foreign central banks bidding through primary dealers or brokers, and this is an indicator of overseas demand.

The direct bid ratio was 27.9%, a record high. Direct bidders include hedge funds, pension funds, mutual funds, insurance companies, banks, government agencies, and individuals, serving as an indicator of domestic U.S. demand.

As the “buyer of last resort” for unsold supply, primary dealers received only 7.6% allocation in this round, one of the lowest levels on record, highlighting strong real demand.

Financial blog Zerohedge commented:

After three stellar coupon Treasury auctions last week, disregarding the panic sparked by “Liberation Day basis trading”, 10-year Treasury yields have dropped to their lowest level since October last year. With the Fed expected to cut rates by at least 25 basis points at the September meeting, the market had almost no anxiety about today’s 20-year Treasury auction.

It turns out this mentality was correct. Overall, this was a very strong auction, with a record high direct bid ratio as this month’s highlight. Demand was clearly ample.

After the auction results were released, the 10-year Treasury yield also fell to the day's low.

U.S. Mortgage Rates Hit Three-Year Low

According to Mortgage News Daily, the average 30-year fixed-rate mortgage rate dropped sharply by 12 basis points from Monday to 6.13%, the lowest level since the end of 2022.

Matthew Graham, Chief Operating Officer of Mortgage News Daily, said:

The overall trend is reminiscent of September 2024, when mortgage rates fell before the Fed meeting because there was an almost 100% certainty of a rate cut. At that time, after the Fed announced a rate cut, mortgage rates paradoxically rose. The same thing could happen this time, though it’s not inevitable.

This phenomenon also fits historical trends. Willy Walker, CEO of commercial real estate firm Walker & Dunlop, said similar trends have occurred in the past:

If you look back at the nine Fed rate-cutting cycles over the 45 years since 1980, those that occurred in recessionary environments eventually pushed down the long end of the yield curve—lowering 10-year and 5-year yields.

In non-recessionary environments, like now, long-term rates are typically not affected. So even though I expect we’ll at least see a 25 basis point cut, followed perhaps by another 25 basis point cut, even if the short end of the curve is cut by 50 basis points, I don’t think it will have a significant impact on the long end.

Yields are currently well below the level of two to three weeks ago. I won’t try to predict the direction of rates, but I think the market may "buy the rumor, sell the fact". After the Fed actually announces a 25-basis-point cut, we could see a small sell-off in 10-year Treasuries.

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