Does the Ugly Bond Auction Matter?
Updated: 2015-04-13, 08:55:39 ET
Analyst: David Kelland
Thursday's $13 billion 30-year Treasury bond auction was met with very weak demand. A Treasury auction is essentially a Dutch auction where participants can submit competitive or noncompetitive bids. The noncompetitive bids are guaranteed to be filled at the highest accepted bid. The competitive bids are then filled beginning with the lowest yield until the entire value of the auction ($13 billion in this case) has been allotted.
The bid-to-cover ratio was 2.18 for Thursday's auction, so there were bids for $28.3 billion worth of government bonds versus only $13 billion that were filled. Never minding that this metric does not take into account the price of those bids, this number is much lower than average. March's bond auction also had a bid-to-cover of 2.18, but that was the lowest reading since May of 2014.
Another important indicator of the strength of demand in a Treasury auction is the "tail" or the "stop-through". Treasuries can be traded on a 'when-issued' basis where a price for the notes or bonds is agreed upon but the exchange of cash and securities does not happen until the securities are issued. The difference between the high yield of the auction and the yield of the when-issued (WI) securities just prior to the auction is called 'the tail' if the WI yield was lower than the high yield, and the 'stop-through' if the WI yield was higher. Auctions are said to have 'tailed' or to have 'stopped through." Thursday's bond auction tailed 2.7 basis points which is quite bad.
The'indirect bid' is the percentage of the bid value that does not go through a primary dealer. This metric is used as a proxy for foreign central banks' bidding interest. The indirect bid for Thursday's auction was 51.2%. Only 4 auctions of the 64 since the beginning of 2010 have had indirect bids over 50%. In late 2011 and early 2012, the indirect bid was usually between 25 and 35. One might say that foreign central banks have a serious appetite for 30-year bonds.*
The "direct bid" is the percentage of the bid value that is being bought by hedge funds, mutual funds, insurers, dealers, etc. and is bought to be held by that party -- not on behalf of another party.
The bond market's initial reaction to the auction result was not good, and the cash 30-year Treasury lost one point immediately. What the weak auction means for prices going forward is less clear. Going back through the price data after bad auctions from 2011 onward, there is no discernible pattern to bond prices following weak auctions, which is as the efficient market hypothesis would have it. In the chart below, I put a down arrow at each auction that garnered less than 10% of a direct bid. I then marked each auction that had a bid-to-cover of less than 2.2 with an up arrow. Selling bonds after bad auctions (according to those two metrics) is by no means a layup trade.
There are some good reasons to be short bonds (and there are good reasons no to be), but the poor auction should not factor into the decision.
David Kelland, Briefing.com
*Of course, central banks are not known for their investment savvy. Gordon Brown famously sold Great Britain's gold reserves at an average price of about $275/troy oz. and, more recently, many central banks were buying gold at $1500/troy oz.