(July 2012) How much do treasury auctions impact treasury rates? This is the question that I wanted to find out when I contacted James Forest, a Ph.D. Candidate at the University of Massachusetts – Amherst and research associate at the Institute for Global Asset and Risk Management (INGARM) has written the research paper, “The Effect of Treasury Action Results On Interest Rates: 1990 – 1999”.
Fortunately, James was willing to offer an honest assessment. He told me that the paper’s results were specific to the 1990s and that, in recent years, the relationship between US Treasury auction announcements and interest rates have likely changed significantly. The data from which the paper’s results were derived are from a decade when the government was running significantly smaller deficits and reducing the size of bond offerings on a fairly consistent basis. In fact, by the turn of the century, the Treasury had eliminated auctions of government bonds at several maturities – including the benchmark 30-year bond.
However, during the last decade, larger and larger deficits have increased US Treasury borrowings for numerous reasons. He suspected (but took pains to indicate that he had not researched) that Treasury auctions would have likely exerted an even bigger impact on interest rates. The idea is the bigger the amount of debt being auctioned, the more likely the market might have a problem “digesting” the new supply as it came to market.
While the exact numbers might not be exactly consistent between now and a decade ago, I think the some of the general ideas which the paper discussed are still valuable.
In the paper, he reached the following conclusions
- Treasury auctions in general have the capacity to create interest rate volatility but, the effect of surprises in FOMC tends to be much greater. His study indicated that, auction days had as much as 40% greater interest rate volatility than non-auction days (even when adjusting for effects of macroeconomic data announcements which also have the capacity to move the market). However, on days which the FED announced interest rate policy (every six weeks) were as much as 130% more volatility than non-announcement days. In others words, FED announcements had the capacity to exert 3 to 4 times the impact on the market compared to Treasury auctions. Yet the auctions were still a very important signal for market participants.
- Surprises in Bid-To-Cover ratio create market reaction. The bid–to-cover ratio is the ratio of the total bids to accepted bids. Forest’s research showed that surprises in this number tended to have the same impact as a surprise in a second-tier economic release, such as consumer confidence. A higher-than-expected bid-to-cover ratio would indicate strong auction demand and tend to push prices higher and interest rates lower – as fixed income rates and prices vary inversely. Conversely, a lower ratio would indicate weak auction demand which tends to push prices downward while increasing interest rates.
To provide a context for this article I pulled the following chart from Bloomberg for bid-to-cover ratios for the 10-year Treasury note for the last 5 years. The chart suggests that a typical bid-to-cover ratio for this bond is around 3.2. More than 3.5 would be a significant upside surprise and below 2.8 would be a downside surprise. It is notable that bid-to-cover ratios were much lower – indicating weaker demand – during the recession and as the government increased borrowing to fund stimulus programs – which included increased spending and lower tax revenue (stemming both from tax cuts and higher unemployment). Noticeably, the past two years has seen higher ratios as the Federal Reserve and Treasury have engineered “Operation Twist” in an effort to lower long term rates. During this period the Fed had actively purchased treasury notes, keeping long-term interest rates low to support the weak housing market.
Recent Bid-to-Cover Rations 10 Year Treasury
For more on the US Treasury Rate, go here..