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Auction Analysis from Fundamental Module
- Treasury securities are brought to the market via an auction process. It is their beginning, their birth, their creation. Understanding auctions are pivotal to Treasury investing. An investor can participate in the auction either as non-competitive or competitive bidder. As a non-competitive bidder, the investor agrees to accept the yield determined by the auction process. However, as compensation for the uncertainty of the yield, the investor is guaranteed to receive allocation. Competitive bidders enter a rate they believe is fair value for the security being auctioned, typically based on a preliminary rate called “when-issue bid” (this will be discussed in further detail). For instance, if the preliminary yield indication for a 2-year note is 2.35% and the investor believes it should be closer to 2.40%, they can submit that bid for the amount they wish to invest. However, depending on the final yield of the auction (the high yield awarded), the bid may be accepted in the full amount, if the rate specified is less, accepted less than the full amount requested, if the bid is equal, or not awarded if the rate specified is higher than the yield set at the auction.
- The 4-week and 8-week bills are auctioned on Thursdays. The 13-week and 26-week bills are normally auctioned on Mondays.
- The 52-week bills are normally auctioned on Tuesdays every four-weeks. Cash management bills are auctioned as the Treasury has financing needs.
- The 2-year, 3-year, 5-year, and 7-year notes are auctioned on a monthly basis.
- The 10-year note is auctioned at the quarterly refunding in February, May, August, and November. They are also auctioned as, “re-openings” in January, March, April, June, July, September, October, and September. The reopened security is as it sounds, an existing security being auctioned for the second time. It has the same maturity date, cusip, coupon interest rate, and interest payment dates but has a different issue date and typically the price has moved with changing market conditions from the first auction.
- The 30-year bond is auctioned at the quarterly refunding in February, May, August, and November. They are also auctioned as, “re-openings” in January, March, April, June, July, September, October, and September.
- Treasury FRNs are auctioned in January, April, July, and October. They are also reopened in February, March, May, June, August, September, November and December.
- The 5-year TIPS are auctioned as original issues in April and as reopening in August and December.
- The 10-year TIPS are auctioned as original issues in January and July and as reopening in March, May, September, and November.
- The 30-year TIPS are auctioned as original issues in January and July and as reopening in March, May, September, and November.
Treasury STRIPS are not directly issued to investors through auctions. They must be purchased from financial institutions and government securities brokers and dealers.
|Security Type||Min Investment||Min Trade|
|Max Purchase||Current Maturities||Tax Treatment||Discount or|
|Treasury Bill |
|$100||$100||Non-comp: $5 million|
35% of offering amount
|4-week, 8-week, 13-week, 26-week, 52-week, CMT as necessary||Interest is exempt from state and local taxes, subject federal taxes.||Sold at a discount to par and pays interest at maturity.|
|Treasury Notes |
|$100||$100||Non-comp: $5 million|
35% of offering amount
|2, 3, 5, 7, 10-year||Interest is exempt from state and local taxes, subject federal taxes.||Pays semi-annual interest rate and principal at maturity.|
|Treasury Bonds||$100||$100||Non-comp: $5 million|
35% of offering amount
|30-year||Interest is exempt from state and local taxes, subject federal taxes.||Pays semi-annual interest rate and principal at maturity.|
|Treasury FRN||$100||$100||Non-comp: $5 million|
35% of offering amount
|2-year||Interest is exempt from state and local taxes, subject federal taxes.||Pays quarterly interest payments.|
|Treasury TIPS||$100||$100||Non-comp: $5 million|
35% of offering amount
|5, 10, 30-year||Interest is exempt from state and local taxes, subject federal taxes. They pay federal income tax on interest payments they received and on growth in principal in the year it occurs.||Pays semi-annual interest rate and principal at maturity.|
|Treasury STRIPS||$100||$100||N/A||6 mo. to 30-years||Interest is exempt from state and local taxes, subject federal taxes in year it matures.||Pays at maturity.|
Above is an actual announcement from www.tresaurydirect.gov. Treasury Direct is the website in which the US Treasury releases information regarding auction announcements and data. This announcement is for a 3-month T-bill, maturing March 7th, 2019. The offering amount for this 91-day T-bill is $39,000,000,000. This maturity is a re-opening of a previous auction held on September 6th (originally a 6-month) therefore there is already $42,001,000,000 outstanding. The cusip is a 9-digit identifier by which you distinguish various maturities. All domestic fixed income instruments have a 9-digit cusip and are similar to international bonds ISIN. We have the basic information. Now we will move to the actual bidding process.
- Auction Analysis – “Roll” and Bidding
- The day of the auction, the first thing to do is look at the “when issue bid” (WI-bid) (see below). In this example, the WI-bid will be 2.35%. The “WI-bid” is a gauge of the current market rate of the T-bill that you are bidding. The “WI-bid” is derived from auction participants entering their competitive bids. For instance, one investor might bid 2.30% for the 3-month T-bill while another participant enters a bid of 2.40%, the result is a “when-issue bid” of 2.35% (this is an oversimplification of the actual process, but the premise is the same).
- The next step in the process is to gauge whether the “roll” makes it advantageous to participate in this week’s T-bill auction. The roll is a straightforward concept and understanding it can determine whether the T-bill being auctioned is trading rich or cheap to the previous week’s recently issued T-bill. The “roll” is simply the selling the “on-run” T-bill and buying the current auctioned T-bill. In our example, the current “on-run” is the February 28th, 2019, trading at 2.30%, and the average “roll spread” is .03 (in this example the right side of 3M ROLL – .05).
WI 3-MONTH 2.34/2.35
3M ROLL -.03/.05
- To find the ask (aka to the right side of -.03/.05, selling the 02/28/2019 T-bill and going into the auction) you merely take the bid side (left side of 2.30/2.31) of the 02/28/2019 and subtract it from the ask (right side of 2.34/2.35) of the WI 3-month, which equals 5 basis points. So, by selling the 02/28/2019 bill at 2.30 and bidding in the 3-month “when issue” at 2.35 you are gaining 2 basis point.
- Let’s find the bid side now of the 3M roll. To find this, you take the bid side (aka the left side of 2.34/2.35) of the WI 3-Month and subtract that by the ask (the right side of the 2.30/2.31) of 02/28/2019, which in this case equates to -.03.
- Now that we have the roll rate let’s see how that stacks up against previous auctions. From the chart above, at .05, it would make sense to participate in this auction as the amount gained by selling the “on-the-run” and going into the auction is higher than its .03 average. While these are both T-bills with the same credit and only one week apart, there are factors that need to be considered. Bloomberg defines four variables that an investor needs to be compensated for when “rolling” into an auction.
- Curve – This is the value of extending your maturity by one week. In this case, moving from the 02/28/2019 T-bill to 03/07/2019 T-bill. Extending your maturity and modified duration should be compensated for the increased risk, no matter how small.
- Carry – Since the newly auctioned T-bill is a forward settle, i.e., it will be auctioned on Monday and will settle on Thursday, the investor is giving up 3 days of interest to invest in this security. As such, compensation should be included in the yield of the auctioned security.
- Liquidity – “On-the-run” maturities like the 02/28/2019 are typically more liquid, meaning that they are easier to buy and sell. The more liquid the issue, the more offers to buy and more offers to sell. As a result of the higher number of bids and offers, the smaller the bid/ask spread (In our example the bid-ask spread is the difference of 2.30/2.31 or .01 for the 02/28/2019 T-bill)
- Adjustment for bad days – Sporadically a bond may mature on the weekend. When this happens, you are essentially losing a day or two of interest while that money sits in cash.
- Considering these factors, we can increase our yield by investing in the WI bill, and the roll spread is above the average, we can proceed to the bidding process.
- Now that we have completed our roll analysis, the bid can be entered. As discussed before, there are two ways to “bid” a T-bill auction, competitive and non-competitive. A non-competitive bid (non-comp) means that you will receive whatever yield is issued. For instance, if you place a non-comp bid when a T-bill is trading at 2.35%, and by the end of the auction it is issued at 2.30%, you will receive the 2.35%, if the yield rises to 2.40% at the end of bidding, you will receive 2.40%.
- These numbers are what we call basis points, which is 1/100th of a percent, or 1% equals 100 basis points, and .01% is 1 basis points. The “when issue bid” is currently trading at 2.35% or 235 basis points. If the investor is satisfied with this yield and does not believe that it is going to change drastically, they might enter a non-comp bid. The max limit for a non-comp bid is $5,000,000 though, so as long as the investment is under that limit, it is an option. Typically, non-comp bids are entered because the investor wants to ensure that they will get full allocation. If the competitive bid is too high, no allocation is possible, which would necessitate buying the bill in the secondary market. Buying in the secondary market, especially with a strong bid to cover ratio, will likely result in a decreased yield from the high yield auction rate. T-bills can’t be issued lowered than at a 0% yield. During the early 2010’s, many investors would participate in the auction as they would be assured at least 0% yield. Since secondary market bills (non-new issue bills) can trade at negative nominal yields, by going into a bill auction, one can ensure that they do not take a loss on their investment (as long as they hold to maturity). It is important to note that the latest a non-comp bid can be entered is 11:00 am eastern time (12:00 ET for FRNs, notes, bonds, and TIPS).
- Let’s next look at a competitive bid. Like non-comp bids, there is a limit to how much you can bid. Based on our announcement above the total amount being offered is $39,000,000,000 for the 3-month T-bill, the limit that can be offered is 35% of that number, in this case, $13,650,000,000 (which is denoted “Maximum Recognized Bid at a Single Rate”). Competitive bids are generally utilized when there is a need for more than the $5,000,000 threshold of non-comps, or if the current level of the “when issue bid” does not meet your criteria. Let’s say, the “when issue bid” is trading at 2.35% and you know that in the last couple of weeks that it has steadily increased by 5 bp between the hours of 10 and 11 am eastern time. Let’s say that you have $10,000,000 to invest; an extra 5 bps would equate to an extra $5,000 in income. However, with the increase in income, there is also risk of not getting full allocation if the “high yield” is issued below the investors competitive rate. It is up to each PM to decide for themselves if the extra $5,000 in income is worth the risk of not getting the full allocation. In this case, with $10,000,000 to invest, I would enter $5,000,000 non-competitive bid at 2.35% (meaning we are assured to get full allocation at that rate) and due to the fact that over the previous weeks the WI-bid has been increasing by an average of 5 bps between 10 and 11 am, I would enter the additional $5,00,000 at 2.40%. Like non-comps, there is a time limit, and for competitive bids, it is 11:30 eastern time (1:00 pm ET for FRNs, notes, bonds, and TIPS).
- Now that the bid has been entered, it is time to analyze the results. As we discussed previously, the cut-off for non-comp is 11 am, and the cut-off for the comp is 11:30 am. The results of the auction are published at 1:00 PM eastern time and from this, we can ascertain if there was an auction tail. An auction tail is the difference between yield of the WI-bid at the particular cut-off time and the published, high rate yield. For instance, if the WI-bid was 2.35% and the published high yield is 2.37%, the auction tail would be 2 bps. The auction tail is watched by market participants as the extra basis points translates to actual money government must pay at maturity. www.treasurydirect.gov
- From the results, this 91-day T-bill, cusip 912796QZ5, settles November 25th and will mature February 23, 2019. This bill was issued with a “high rate” (the high rate is the rate at which the T-bill is issued) of 2.365%. Notice that the WI-bid shown above was 2.35%, if you had entered a non-comp bid, you would receive 2.365%, better than the time that you entered the bid. The reason that the WI-bid increased from .015% is that it is a compilation of competitive bids and from the bid indication above to the closing time of competitive bids at 11:30, investors “bidded” up the yield. Bidding up the yield means that the bids entered after this time were averaged higher than 2.35%. This actually decreased the price, thus increasing the discount and incidentally increased the amount of interest that the government had to pay back. The tender amount (the dollar amount of bidders for this auction) was $127,105,545,600 with $125,785,549,500 in competitive bids (remember, competitive bids are what make the market, meaning that the average of the competitive bids sets the issue rate of the bill) and $1,034,996,100 in non-competitive.
Now let’s get to the meat and potatoes of the auction results, the bid to cover, primary dealer allocation, indirect bidding allocation, and direct bidding allocation.
- Bid to Cover ratio – Above is the “Treasury Auction Results” published on the website, www.treasurydirect.gov. The release states that the bid to cover ratio was 3.26, this means that for every $1 offered there was $3.26 worth of demand. This ratio is very important as it tells us the demand for the security. Typically, a bid to cover ratio above 2 means that it was a successful auction. Anything under 2 means that it is a “failed auction” and can mean that investors have a negative view of our debt. To calculate the bid to cover ratio you divide the amount “tendered” by the amount accepted. We know from the offering announcement that the total amount to be auctioned was $39,000,000,000. From the “Treasury Auction Results” we see that the final amount accepted was $39,000,097,600, the amount “tendered” was $127,105,545,600, divide those two numbers together we get the number 3.26. Based on the number of investors who submitted bids compared to the amount offered there was a great deal of demand for this T-bill.
- Primary Dealer – Primary Dealers are submitters bidding for their account. These are large investment houses (JP Morgan, Morgan Stanley, Goldman Sachs, etc.) that bid in the auctions, then sell the securities to their clients. In general, a high primary dealer allocation can lead to weakness in the price of treasury tenor. This is due to Primary Dealers participating in the auction to re-sell the treasuries in the secondary market, and if there was not a strong direct or indirect bid, they must increase the yield (thus decrease price from high yield), to entice buyers. Here is a list of the current 23 primary dealers. https://www.newyorkfed.org/markets/primarydealers.html. In this case, the primary dealers were awarded 42% ($16,135,872,000/$37,680,101,500) which compared to the month before was in-line.
- Direct Bidder – Direct bidders are non-primary dealer submitters bidding for their house accounts, i.e., for the bidder’s “proprietary” accounts. Examples of direct bidders would be domestic trust, banks, mutual funds. In general, the market likes to see a high allocation to direct-bidders because it shows demand from domestic institutions. In this case, the primary dealers were awarded 7% ($2,680,400,000/$37,680,101,500) which compared to the month before was in-line.
- Indirect Bidder – Indirect bidders are customers placing competitive bids through a direct submitter, including Foreign and International Monetary Authorities placing bids through the Federal Reserve of New York. Market practitioners monitor this to gauge international demand for our bonds. Weak international participation can have a significant effect on not only our domestic rates but also the price of our dollar. Like, “Direct bidding,” market practitioners want to see the percentage allocation higher than primary dealers. In this case, the primary dealers were awarded 50% ($18,863,829,500/$37,680,101,500) which compared to the month before was in-line.
- The truest way to ascertain if participation percentages are in-line, its best to compare them to their 1-year averages. Please see our weekly publication, “The CICA Treasury Auction Report,” for the averages for notes, bonds, and TIPS. www.investinginbonds.com