by Chris Black
Treasury auctions occur regularly, and ~300 public auctions are held each year.
Here’s we’ll review the auction process, and how to interpret auction results.
First, let’s clarify some of these terms: Treasury bills include debt maturing in one year (52 weeks) or less, notes mature in 10 years or less, and bonds have maturities beyond 10yrs. Treasury Inflation Protection Securities (TIPS) and Floating Rate Notes (FRNs) have various maturities. These can all be referred to casually as ‘bonds’, but traders never refer to anything above 10-years as a ‘note’.
First, to participate directly, a bidder must have an established account. Institutions use TAAPS (Treasury Automated Auction Processing System), and individuals use a TreasuryDirect account.
Individuals can only place non-competitive bids, where they agree to accept whatever discount rate (yield) is set by the auction. Institutions, however, can place either non-competitive or competitive bids, where the bidder specifies an interest rate they are willing to accept.
In effect, institutions can bargain.
Institutions can also trade in advance of an auction, and then settle with each other when the auction happens. This is called the when-issued market and is pretty important to our discussion, so we’ll talk more about that in a bit.
Once an auction begins, the Treasury first accepts all non-competitive bids and then auctions off the remainder of what it’s looking to raise.
This is where competitive bidders are unsure whether they’ll be filled at their price. The process is called a Dutch auction.
Let’s take an example: Say the Treasury wants to raise $100 million in 10-year Notes with a 4% coupon. It receives $10 million of non-competitive bids.
The Treasury first accepts all these non-competitive bids and reduces the amount left for the Dutch auction to $90 million. Then, say it receives the following competitive bids:
• $25 million at 3.88%
• $20 million at 3.90%
• $30 million at 4.0%
• $30 million at 4.05%
• $25 million at 4.12%
The bids with the lowest yield will be accepted first and then ascend up until the auction is filled.
After first accepting $10 million of non-competitive bids, then all competitive bids up to 4.0% ($75 million), then $15 million of the 4.05% bids for $90 million total. So, those who bid 4.05% would receive half of their orders filled.
At auction’s end, all bidders receive the same yield at the highest accepted bid. In this case, $100 million of Treasuries were auctioned off at 4.05%
On the face of it, this looks pretty bad, as the Treasury had to offer a higher yield to raise its target amount. But how bad? And how can we tell?
The answer lies in the expectations of pricing.
Now that you understand the logistics of a Treasury auction , let’s turn to how to interpret auction results.
We’ll review the BTC ratio, the high yield, auction tails, and a failed auction.
1) Bid to Cover Ratio
One of the first things traders look at is the Bid to Cover ratio (often referred to as BTC). A simple statistic, this is just the total amount of bids received divided by the amount of bonds sold at an auction.
In the previous auction example , the total bids amounted to $140 million and the auction was for $100 million of notes, so the BTC ratio would be 1.4x (which is disastrously low btw).
We can see towards the bottom of the results page (www.treasurydirect.gov/instit/annceresult/press/preanre/2023/R_20231109_3.pdf) that yesterday’s 30Y auction had a BTC of 2.24 (which is also horrendous).
Like many stats, what we’re often looking for is changes from prior periods: Is the BTC ratio rising or falling? And how rapidly?
If market liquidity is drying up, this would be a good first indicator. If the BTC were to drop low enough, it’s a major red flag.
2) The High Yield
Another, usually much more important, metric to keep an eye on is the stop price, aka the high yield — the actual yield received by bidders in the auction.
Remember how we said these securities trade in a when-issued market before and leading up to an auction? This creates what is called the snap price. It sets the price expectations for an auction and is a critical piece of information for investors.
Was the auction overbid or underbid?
In overbidding, the stop (high yield) is lower than the snap (when issued yield), and this is usually seen as a strong auction. With underbidding, the stop is higher than the snap, indicating a weak auction.
3) The Auction Tail
Another thing we’re looking for with the high yield, and a bond-fan favorite is called the auction tail. The tail is the high yield minus the bond’s when-issued yield.
If there is no measurable tail, we say that the auction finished on the screws. A negative tail means that the auction went better than expected, with higher-than-expected demand.
But positive tail (a tailing auction) tells us the auction did not go well because the yield realized in the auction exceeded market expectations, meaning weaker-than-expected demand.
Bottom line, the tail measures unanticipated Treasury demand shifts before auction.
The larger the tail, the worse the auction.
And if we ever see a tail in the 4, 5, or 6bp range, this would be considered disastrous in the bond world and mean things are breaking down in US Treasuries.
Yesterday’s tail in 30Y was 5.3bp.
4) Total Fail
Going back to the BTC Ratio, you may wonder what happens if Treasury holds an auction and receives fewer bids than face value of the securities they’re selling.
This would mean the BTC falls below 1, and the Treasury failed to raise as much money as they expected.
In the bond world, this is a failed auction and nothing short of catastrophic for the US Treasury.
BREAKING: Moody’s cuts U.S. credit outlook from stable to negative.
Reasons for the cut:
1. Downside risks to U.S. fiscal strength have increased
2. Fiscal deficits to remain very large
3. Debt affordability to be significantly weakened
Since the debt ceiling crisis “ended”…
— The Kobeissi Letter (@KobeissiLetter) November 10, 2023
Last week’s TBAC (home.treasury.gov/system/files/221/TBACCharge1Q42023.pdf), particularly the section named “Government Supply”, lays out the downgrade pretty clearly (and surprisingly honestly):
It’s the debt, stupid!