How to Read a Treasury Bond Auction

Prices at these affairs can influence interest rates and change the course of the economy

• Treasury auctions have a significant impact on interest rates and the economy.
• The Treasury sells bonds in auctions with a fixed size.
• The Treasury typically aims to sell the same number of bonds at each auction.

The U.S. government raises funds by selling debt securities at Treasury auctions. These are short-term Treasury bills (with maturities of four weeks to 52 weeks), medium-term Treasury notes (that have maturities of 2, 3, 5, 7, or 10 years) and long-term Treasury bonds (that mature in 20 or 30 years). 

Treasury auctions have a significant impact on interest rates and the economy, so bond traders should know how to read and analyze them. Let’s examine some Treasury auction results and see how to use them to gain insight into economic conditions and trading opportunities.

The auction schedule

The U.S. Treasury Department announces the auction schedule and the details of each security, such as the amount, the maturity date and the type. A typical schedule looks like this, detailing the action type (or security type), the auction date and the issue date (or settlement date):

The auction size

The Treasury sells bonds in auctions with a fixed size, and it typically aims to sell the same number of bonds at each auction, unless the auction is weak, and the Treasury does not get enough bids to cover the size.

You can compare the size of the auction with previous auctions (for each bond) to gauge the reliability of the bid-to-cover data. If, for example, the auction size is much smaller than before, it is normal to see higher bid-to-cover ratios than in previous auctions.

Sometimes, the auction size may increase unexpectedly. This can lower the bid-to-cover. The market reaction depends on why the size increased. If it is because the buyers wanted more of that bond and the price was still normal, this is a good sign. But if the size increased and the price was lower than normal, it means the seller was trying to sell more bonds than the market wanted, which is a bad sign.

Reading pricing data

The auction prices are the best way to judge the auction strength because they show the real demand and supply of the bonds. The bid-to-cover ratio can be misleading because some dealers may bid very low prices that do not reflect their true willingness to pay.

The auction prices show how much the buyers paid for the bonds compared to the market price before the auction ended (the “snap price”). If the buyers paid more than the snap price, they overbid. If they paid less, they underbid. Overbidding means high demand and underbidding means low demand for the bonds. But overbidding and underbidding differ for different bonds. Some are usually overbid, while others are usually underbid.

To measure the auction strength, traders need to see how the current overbidding or underbidding compares to the past overbidding or underbidding of the same or similar bonds. The more the buyers overbid or the less they underbid, compared to the past auctions, the stronger the auction is.

The bid-to-cover ratio

The bid-to-cover ratio tells us how much the buyers wanted the bonds relative to how much was offered. The higher the ratio, the more bids there were for each bond, which means a better auction. Traders look at how the current ratio compares to the past ratios of the same or similar bonds. They may use the average of the last few auctions as a reference point. A higher-than-average ratio means a strong auction, and a lower than average ratio means a weak auction.

The bid-to-cover ratio is a simple and popular way to measure the auction strength because it shows the balance between demand and supply. But the ratio may not be very accurate because some dealers may bid very low prices that are unlikely to win, which inflates the ratio. So the bid-to-cover ratio may not be the best indicator of the auction strength.

The price tail

The price tail shows how much variation there was among the buyers in an auction. It is the gap between the average price and the cut-off price (the lowest price that got a bond in the auction). A large price tail (or, “the auction tailed”) means that the buyers who barely got the bonds paid much less than the others . This is not a good sign because it suggests the demand for the bonds was low. On the other end, a good sign would be if the prices at the auction are higher than when issued (or “stopped through”). In general, we evaluate the price tail by comparing it to previous auctions.

Competitive vs. non-competitive bids

Small investors and individuals usually bid non-competitively. They are sure to get the securities they want, but they can only buy up to $5 million worth of some securities.

Big investors, such as institutions and foreign countries, bid competitively. They can buy more securities, but they have to compete with other bidders. They cannot purchase more than 35% of the securities offered to the public.

A Recent Treasury auction result

The U.S. Treasury releases auction results on TreasuryDirect.gov. 

Christopher Vecchio, CFA, tastylive’s head of futures and forex, has been trading for nearly 20 years. He has consulted with multinational firms on FX hedging and lectured at Duke Law School on FX derivatives. Vecchio searches for high-convexity opportunities at the crossroads of macroeconomics and global politics. He hosts Futures Power Hour Monday-Friday and Let Me Explain on Tuesdays, and co-hosts Overtime, Monday-Thursday. @cvecchiofx  

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