Why discount rates were lower at Treasury bill auctions

Market Realist

Overview: High-grade borrowers are upbeat about market conditions (Part 7 of 9)

(Continued from Part 6)

U.S. Treasury bill auctions in the week ended August 8

The U.S. Treasury held weekly auctions for the four-week, 13-week and 26-week Treasury bills for $40 billion, $28 billion, and $25 billion, respectively, in the week ending August 8. Treasury bills (or T-bills) include the securities that mature in less than a year. T-bills are offered at a discount to face value, the discount rate, and are redeemable at par on maturity.

Last week, the U.S. Treasury auctioned six-month Treasury bills worth $25 billion on August 4. The amount was slightly higher than the $24 billion auctioned in the previous week.

Bid-to-cover ratio falls

Despite the higher auction amount for six-month T-bills, the bid-cover ratio increased by ~3% to 4.87x, compared to 4.73x recorded in the July 28 auction. The ratio has averaged 4.82x for all auctions held in 2014. The bid-to-cover ratio is computed as the total value of bids received divided by the value of securities on offer. The higher the ratio, the higher the demand for the securities on auction.

Market demand rises

The share of primary dealer bids in the August 4 auction increased to ~67%, compared to ~54% in the July 28 auction. The percentage of direct bids increased marginally to ~4% of competitive accepted bids on a week-over-week basis. The percentage of indirect bids decreased to ~29% from ~43%, compared to the July 28 auction.

An increase in the percentage of primary dealer bids is a sign of weaker fundamental market demand. Primary dealers are a group of 22 authorized broker-dealers who are obliged to bid at U.S. Treasury auctions and clean up excess supply. They include firms such as JPMorgan Securities LLC and Goldman, Sachs and Co. Both financial firms are part of the S&P 500 Index (IVV).

While direct bids stem from domestic money managers like BlackRock (BLK) and institutional investors like American International Group (AIG), indirect bids include demand from foreign governments and central banks.

Yields analysis

The high discount rate for the August 4 auction came in slightly lower at 0.05%, compared to 0.055% in the July 28 auction. The average discount rate for 2Q14 came in at 0.053%—lower than the 0.074% in the 1Q14.

Lower discount rates were a feature seen in all three T-bill auctions held last week. A lower discount rate for short-term securities like T-bills, implies that markets are more sanguine about the future path of interest rate increases.

Investor options

You can invest in Treasury bills through exchange-traded funds (or ETFs) like T-bills including the iShares Short Treasury Bond Fund and the PIMCO Enhanced Short Maturity Strategy Fund (MINT). Others like the iShares 10–20 Year Treasury Bond, the iShares Barclays 20+ Year Treasury Bond Fund (TLT), and the ProShares Ultra 7–10 Year Treasury ETF invest in long-term Treasuries.

Continue to Part 8

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