Bond Expert Thursday Outlook: Six Months to Christmas

Prices of Treasury coupon securities are posting very modest gains in overnight trading. As I peruse the news there does not appear to be any story guiding prices higher. There is residual discussion of the US durable goods report and conversations about the FOMC statement but there is no real information there.

There is some economic data today and that data has the potential to stir the investing pot. The Labor Department will release the weekly initial claims data at 8:30AM New York time. The consensus is for 600K versus 608K last week. The four week moving average is 616K and that number has declined slowly from its peak of 659K ten weeks ago.

Last week continuing claims fell for the first time this year. Economists are unsure if that decline represents exhaustion, volatility or real improvement. Another decline there would be tangible evidence of economic stability.

The Treasury will auction a fresh batch of 7 year notes today ($27 billion). The first two auctions went well and I think that will be a difficult task to accomplish for a third consecutive day. The 7 year has not been beloved and I think the dealers will extract a concession from the taxpayers today.

There has been some confusion regarding the indirect bidding category and the bloated percentage of bids in that category.

I posted the page which describes the change. I do not quite understand the change and I do not recall the process in my days at a primary dealer.

The current bidding procedure is relatively new and is called a single price auction or Dutch auction. If you bid in the auction you are awarded bonds at the price which clears the auction. So in the 7 year auction today, if an investor bids 3.40 percent and if it took a bid way back at 3.50 to clear the auction, then the 3.40 bidder would own the bonds at the 3.50 percent clearing price. The practical effect is that there is no penalty for bidding in front of the market.

Under the old system there were multiple pricing points. In the example which I used the bidder at 3.40 percent would own securities at that level and every bidder from 3.40 back to the clearing level of 3.50 would own bonds at the level at which they submitted a bid. In a sense the process discouraged expensive bids because there was a “penalty” for bidding too expensively in that you would look rather foolish if you bid 3.40 percent and you could have bought the bonds at 3.50 percent.

In the real world there was never that great a dispersion of bids but even though the dispersion was much less the exercise of picking the high yield (what traders refer to as the tail) became an art form.

How does all of this relate to the indirect bidding category. I am a little murky here. Apparently under the old process dealers would sometimes guarantee a yield level to a customer. When the bid was submitted to the Treasury, the bid was submitted as a direct bid of the dealer firm rather than an indirect bid of the investor client.

As I understand the new regulation it requires dealers to now submit those bids to the Treasury with the name of the client attached. It would no longer be a dealer bid but a customer bid. This change can be instituted because in the so called Dutch process there is only one price point rather than multiple price points.

Treasury believes that the new process will provide it with additional information about the population of bidders. For traders it will make it more difficult to understand the influence of central banks on the process.

The yield on the 2 year note declined 2 basis points to 1.18 percent. The yield on the 3 year note slipped 3 basis points to 1.73 percent. The yield on the 5 year note dropped 3 basis points to 2.72 percent. The yield on the 7 year note fell one basis point to 3.36 percent and the yield on the 10 year note edged lower by a basis point to 3.68 percent. The yield on the Long Bond is unchanged at 4.42 percent.

I run on!

Comments

[Wesley Mouch:]

John,

Thanks for the description of the bidding process.

I suspect the rule change is just as you note, to make less clear the role of the central bankers in the auction. The idea of bidding against a printing press does not sound too favorable to me.

Jun 25 08:01 AM

[Screwloose:]

John

Thanks for taking the time to explain so fully.

There's nothing like changes that improve transparency and clarity.....

Jun 25 09:00 AM