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

On the eve of the Federal Reserve's interest rate decision, on Tuesday local time, the U.S. Treasury auctioned 20-year Treasury bonds, and the auction results showed very robust demand, with the allocation ratio for direct bidders representing domestic demand reaching a historic high. Additionally, on the same day, U.S. mortgage loan rates fell significantly, as investors in mortgage-backed securities seemed to be positioning themselves ahead of the widely anticipated interest rate cuts by the Federal Reserve.

20-Year U.S. Treasury Auction

The winning bid rate for this 20-year U.S. Treasury auction was 4.613%, a significant decrease from last month's auction rate of 4.876%, the lowest level since October 2024. The winning rate was 0.2 basis points lower than the pre-issue yield of 4.615%, marking the third consecutive transaction "below the pre-issue yield."

The bid-to-cover ratio for this auction was 2.74, higher than July's 2.54, the second highest level since March, and above the average of the last six auctions, which was 2.65.

The market's main focus was on the internal data of the auction:

The indirect bid ratio was 64.6%, up from last month's 60.6%. Indirect bidders typically include foreign central banks and other institutions participating through primary dealers or brokers, serving as an indicator of overseas demand.

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

As the "backstop" for all unsold supply, primary dealers' allocation ratio in this round was only 7.6%, one of the lowest levels in history, highlighting strong actual demand.

Financial blog Zerohedge commented:

After three outstanding coupon bond auctions last week, excluding the panic caused by "Liberation Day basis trading," the yield on 10-year U.S. Treasuries has fallen to its lowest level since October of last year, and the Federal Reserve is expected to cut rates by at least 25 basis points at the September meeting, so the market had almost no anxiety about today's 20-year Treasury auction.

This mindset proved to be correct. Overall, it was a very robust auction, with the highlight of the month being the record direct bid ratio, indicating that demand was clearly sufficient.

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

U.S. Mortgage Rates Hit Three-Year Low

According to Mortgage News Daily, the average rate for a 30-year fixed-rate mortgage fell significantly 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, stated:

The overall trend is reminiscent of September 2024, when mortgage rates experienced a similar situation due to the nearly 100% certainty of a rate cut ahead of the Federal Reserve meeting. At that time, after the Federal Reserve announced the rate cut, mortgage rates paradoxically rose. The same situation may occur this time, but it is by no means certain.

This phenomenon also aligns with historical trends. Willy Walker, CEO of commercial real estate company Walker & Dunlop, noted that similar trends have occurred in the past:

If we look back at the nine Federal Reserve rate-cutting cycles over the past 45 years since 1980, those that occurred in a recessionary environment ultimately pulled down the long end of the yield curve—lowering the 10-year and 5-year yields.

In a non-recessionary environment, like now, it does not impact long-term rates. So, while I expect we will see at least one 25 basis point rate cut, followed by possibly another 25 basis point cut, I do not believe that even a 50 basis point cut on the short end of the curve will have a significant impact on the long end of the curve.

Current yields are far below where they will be in two to three weeks. I won’t try to predict the direction of rates, but I think the market may buy the rumor and sell the fact. After the Federal Reserve officially announces a 25 basis point cut, there may be a slight sell-off in the 10-year Treasury