"After yesterday’s dismal 3Y auction, which was nothing short of a disaster across virtually every metric, moments ago the US Treasury sold $24bn in 9-year 10-month reopening CUSIP 5M8, which was about as close to stellar as one can get. The auction priced at a high yield 2.728%, stopping 0.8 bps through the when [sic] issued of 2.736%, and the lowest yield since January 2018, sharply lower than last month’s 2.915%. The bid-to-cover meanwhile jumped from 2.35 to 2.51. The internals were also strong, with indirects taking down 56.9%, below the 65.3% auction average, largely due to a surge in directs which doubled to 20.8%, the highest since May 2015. This left dealers holding 22.3%, far below the 26.0% auction average."
This is not jargon for jargon’s sake. This transcript is the correct way to explain the details of how the US government funds Federal debt, which has ballooned from $8 trillion before the great financial crisis, to about $22 trillion today, says Fitch Ratings. Double-check the numbers I’ve mentioned, then add all global state and supranational debt, corporate and to a certain extent personal debt (securitised mortgages), plus an estimated $190 trillion in interest rate derivatives – and you see that the fixed-income market is many, many times bigger than all equities outstanding. Janus Henderson calculates that in 2018 $1.37 trillion was paid out in dividends globally.
Why so little media coverage? Because this is a field of finance run by and for professionals. It’s a system based on contract law, so legal eagles are closely involved in drawing up the details of each agreement using rules-based precise terminology which is understood by all parties.
It’s also a very lucrative area of banking, where each link in the food chain is handsomely rewarded – no pesky retail to dilute efficient distribution. Deals are struck between principals, and few agents act as intermediaries thus concentrating not just profits, but also price discovery. The more opaque the market, the bigger the room to make a turn between bid and offer prices; also a more generous slice when cutting up the pie of a new offering. Think of an equity IPO where only you know what the market will stomach.
The new bond can initially be offered to a select few clients only, keeping them sweet and onside, and later offered more generally in the secondary market. This is the difference between ‘direct’ bidders who know exactly what they want to pay for a bond – and know that if they underbid they’ll get nothing – and indirects, who are happy to receive a slimmer portion at the average going rate (these tend to be funds).
Like every auctioneer, the seller of new bonds drums up demand, making the process look a success, keeping both buyers and sellers happy; this is the ratio of the number of bids relative to the amount on the block (bid-to-cover).
Central banks and Treasuries have pre-announced auction schedules, retain key staff who are permanently monitoring the market and canvassing opinion for what might sell well. It is in their interest to raise money as cheaply as possible while supplying the insurance and investment industries with paper that suits their needs. In the UK, this is done by the Department for Market Operations which, ‘for operational purposes the day-to-day tactical target is usually to achieve a particular level of interest rates or the exchange rate’ The Old Lady says.
