U.S. Treasury Bond Debt Auctions on a Trend to Failure?
Interest-Rates / US Bonds Feb 14, 2010 - 07:45 AM GMTBy: Fresbee
The latest 30 year bond auction have been disappointing with some already terming it as a failure. This is an opportune time to analyse the trends in bond markets. There is almost a pall of gloom across the many who understand bond market mechanics and we will try to break down two of the most important auctions: 30 year and 10 year auctions, to see the trend and patterns in results. Quoting from Reuters on the latest 30 Year auction:
Results are disappointing for today’s 30-year bond auction where the large $16 billion size made for soft coverage, at 2.36 vs. 2.68 and 2.45 in the January and December auctions. The high rate for today’s auction of 4.720 percent is more than 2 basis points over the 1:00 bid. Note that all three coupon auctions this week show a tail, an indication of soft demand.
Direct bids were a record 24 percent, well above any prior level and follow a large direct bid for yesterday’s 10-year auction, results which will firm suspicions that retail accounts are aggressively bypassing dealers. The large direct bid made for a very soft indirect bid with the group taking only 29 percent of the auction vs. a recent average of 41 percent.
30 Year Bond Auction
Bid cover ratio while is disappointing is not as disastrous as it is being made out to be. But the devil lies in the details as explained below. The bid cover ratio seem to have been manipulated through the direct bidders category which many fear could be the proxy for FED itself.
- The above chart clearly shows the reason why analysts are freaked out at the results. There is a massive jump in the category called direct bidders who as mentioned above took 24% of the auction. The apparent lack of transparency behind this group has increased speculation that the FED could be directly buying its own auctions to keep yields under manageable levels.
- Indirect bidders which is the most important category and pretty much defines the success or failure of the auction turned in paltry 28% of the auction well below its 36-40% levels seen for much of 2009. While it has already got people jumping, we believe we should wait for couple of more auctions to see if this was a one off failure or this is indicating the final currency and bond market crisis that many have predicted.
- More than the indirect bid, it is the direct bid ratio and the subsequent yellow trend line indicating a huge order. FED needs to clearly show who the direct bidders are and failure to do so will fuel speculation which itself can bring down the auction much sooner than the FED might have calculated in its auctioning timeline.
10 Year Auction Results and Trends
- Feb results summary: Direct bidding was heavy with the group taking down 13% of the auction, down from 17% last month but still well over the recent average of 8%. Dealers have been complaining that strong direct bids will undermine how strongly they bid at auctions. Indirect bidders were very soft, at 33% vs. an average of 41%. Indirect and directs combined total 46% to indicate soft demand from non-dealers. Demand for Treasuries fell in reaction to the results.
- The constant falling indirect bidders is a stark reminder of the dangers of loss of appetite for the massive auctions that lie in front of FED. My personal read on the situation is that it could be a seasonal effect and we will see a more healthier auctions come May, June and July. But even the most optimist within me is scared right now of the trend line for Indirect bidders which is almost waiting to fall off the cliff.
- The US-China tip off could flood the market with US secondary 10 year and 30 year into the markets, crashing the sales completely. The trend line on the 10 year and esp on 30 year seem to suggest that markets are watching the souring relationship, like a hawk. Any reconciliation between the 2 giant nations, one (US) overly dependent on the other (China), could see the auctions return to its healthier levels.
- 10 Year Bid cover is not as scary as it has been made out to in number of blog's. It is holding a steady 2.67 level well over the levels in 2009. Yields have seen frequent movements between 3.5 and 4.0 but none that indicates a scare. If the FED is managing it through its own printed money is a completely different story.
- The 10 year seems to be auctioning far better than the 30 year which clearly now is pointing us to markets loss of appetite to digest longer dated auctions. FED had clearly shifted to longer dated bonds in H2 2009 as the economy was not showing any signs of revival and therefore increasing chances of a US default on its near term maturity bonds. If markets continues to reject 30 Y, FED might have to shift back to 2 year and 10 year bonds which will increase the stress on FED balance sheet.
The situation does seem to indicate the first signs of stress and desperation at the FED and if the panic spreads, it could be Lehman all over again except this time it will be 100 times more powerful and catastrophic. It is a blessing in disguise that the common man and media does not understand bond market mechanics to great detail else the last auction could have been recipe for some hard questions from the government. The fact that stocks RALLIED on this news tells you how disconnected stocks are from reality. The Debt Spiral has started and the next few auctions will tell us whether it is accelerating.
As Neil Ferguson quotes in his book “The Ascent of Money”, bond market holds the key to world economics. Rest of the markets are all secondary and derived. It is getting eerily lonely and close to annihilation for the FED. How long it can stretch before its ultimate death is anyone’s guess but the fact they have been able to manage this long is a commendation to their genius manipulation.
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Direct Link to the article: 30 Year Auction: Trend to failure
Source for data: Treasury Direct, FED, Haver Analytics, Reuters Knowledge, Bloomberg
Fresbee
http://investingcontrarian.com/
Fresbee is Editor at Investing Contrarian. He has over 5 year experience working with a leading Hedge fund and Private Equity fund based out of Zurich. He now writes for Investing Contrarian analyzing the emerging new world order.
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