The 2-7 Year Treasury Issuance Paradox; Or Say's Law In Practice

Tyler Durden's picture

Zero Hedge has compiled Treasury Auction data going back to early 2008, for the 3 very critical "no man's land" bonds - the 2 year, 5 Year and 7 Year. We observe that notional increases with each subsequent auction, yet an interesting paradox is that with every single auction (juxtaposed with an ever-greater cumulative sovereign leverage), the demand metrics for auctions have consistently been improving. We compare Bid-To-Cover, Direct Bidder and Tail data. We find as supply increases, both in notional and as a portion of total GDP, demand for USTs increases incrementally more, resulting in ever better auction ratios. We have picked the 2-7 Year points on the curve, as this is where the presumed inflation inflection point will most likely strike based on market expectations. So while purchasing a 30 Year Bond certainly presents inflation expectations considerations as part of the purchase process, the same is not true of 52-week Bills. And the further up the curve one moves, the more of a factor inflation worries become.

Yet oddly, over the past year, it would appear accounts both international and domestic have invested ever more money into the 2-7Y interval. Following today's unprecedented GDP number (which one has the choice of ignoring as David Rosenberg pointed out, due to the certainty that it will not repeat in a long time), one immediate measure of the credibility of this economic data point will be observing the performance of future 2-7 Year bonds (and especially the 7 Year, which has the greatest duration-adjusted sensitivity to yield moves on the curve). If historical trends persist, there is no reason to be concerned that the Treasury will not find a multitude of willing buyers: did Geithner finally figure out how to use Say's law properly? Or is this merely the magic touch of the Federal Reserve and the Primary Dealers, greasing up the market? You decide.


We present the 18 most recent 2 and 5 Year Bond Auction results, as well as the 12 most recent 7 Years. We compare the total size per issue with the Bid-To-Cover for any given auction. The conclusion is that the prevailing size of a typical 2 Year auction has moved up from $32 billion to $44 billion most recently, $22 billion to $42 billion for the 5 Year, and $22 to $32 billion for the 7 Year, Bid To Cover ratio have surged on average about 40% since August 2008 to date.

2 Year Data

5 Year Data

7 Year Data

There is no doubt that BTC ratios have been consistently improving with each auction. Whether this is a function of prevailing excess zero cost capital, or other free money conduits is unknown. However, the rational response of moderating demand with what is obviously excess supply has yet to materialize in even one outlier auction.

Direct Bidder Take Down

While not as much an indication of overall demand, the recent surge in direct bid take down interest has been a very curious phenomenon, and as the charts below indicate most recent auctions in the 2Y-7Y frame have seen double digit Direct take down participation. The charts below map the direct bid participation for each auction over the same time period. Once again, the statistically significant increase in this metric is unmistakable.

2 Year

5 Year

7 Year

We have previously provided some observations on what we believe is the source of the direct bidder take down spike. Yet regardless of the identity, whether this "buyer" will continue to be a material presence is likely not going to be a major impact, as the total notional attributed to direct is usually a low single digit number. In light of $1.7 trillion in net issuance in 2010, this is, alas, peanuts.

Market Tail

Lastly, we look at market tail as an indication of instantaneous surprise relative to prevailing market levels as of 1pm on any given auction day. The tail is merely the difference between the actual and expected auction yield. A negative tail indicates a strong auction, as the yield at auction comes inside expectations, and vice versa for positive tails. As the charts below demonstrate, while the trend is far less strong in this data series, the prevailing trendlines all point to better tails over time, regardless of increasing auction sizes, especially with a longer-dated bias.

2 Year

5 Year

7 Year

The fact that every auction presents seemingly ever higher demand metrics can not be reconciled with either i) the increasing auction notional and ii) the total sovereign debt level in the US, which over the past year has grown by over $1 trillion, and at the current rate of increase will hit a 100% of GDP within the next 12 months. This data is therefore useful for all who look for the fabled "busted auction" - as the data indicate one does not need a busted treasury auction, per se, to find the inflection point (although should we have one, the inflection point will be all too visible all right). All that has to be observed is a plateauing or a decline in any of these ever optimistic metrics. At some point the free money will disappear, and the scramble to find the cash to absorb yet another monthly total of $120 billion in 2s, 5s, and 7s, not to mention another $60 billion or so in 10s and 30s, will start being an issue. Watch for that moment- it will be the catalyst to pull the chips from the UST table.

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curbyourrisk's picture

You guys are way above my pay-grade.  Thank you for being there.

phaesed's picture

Don't forget in the change in direct bidder methodology last year.

Nice article.

Additionally I'd like to point out that it could also be a function of the coupon themselves, which the Fed covertly cleaned out in the Quantitative easing efforts. As banks sold off the high coupon bonds, they purchased the lower coupon bonds at MUCH lower prices yielding exactly the same as the high coupon bonds, while moving the actual cash to their balance sheets. And leaving the arbitrage spreads the same.

The robbery continues.


phaesed's picture

Oh and FYI, Gap close on the SPY... don'tcha love how it's within pennies.... how exceptionally accurate eh?

Oh no manipulation... it's all a random walk.

Orly's picture

Strange things are afoot at the Circle K.

SDRII's picture

where is JJ to refute the anaylysis - lol (selling the belly of the curve at the aspiring primary dealer)

GlassHammer's picture

I had to read it twice but great article.

(will probably read it a third time to get it to really sink in)

I really don't want to think about what happens when the FED pumps stop.

Anonymous's picture

Question for the intelligentsia on ZH (from an ignoramus) -
The Fed has $1.6 T of short term debt due March 31 (or so I hear. Which bonds / bills will the Fed be looking to refinance in order to not get into trouble on this huge short term payment ? Or would they have get yields on all the treasuries across the board ?

Anonymous's picture

Where you get that info (31 March and 1.6T) ?

Anonymous's picture

The graphic is from a NYT article for which I cant get a link.

Anonymous's picture

might be your best analysis / story yet ........ if all this data is accurate , the Wall Street Journal should want to re-run this story on Monday

Anonymous's picture

Tyler geat research as usual - as long as the roll down on the curve is as rewarding as it is the zombie banks will continue to play the carry game in their non-MTM bank "held for maturity" portfolios - much like Japan has for decades. Meanwhile suburban Virginia new hedge fund formation continues to out pace Greenwich CT's....

strike for return to reality's picture

It's easy to have good numbers when you get to make them up.

So long as Treserve buys what they print, the numbers will keep looking good.

Didn't the Soviet collectives always report what their 5-year plans said they would?

Anonymous's picture

Wasn't this "busted auction" supposed to happen by now? Last June? or Sept when the $300bil direct purchase program ended? 2 more monthly auctions and half of fiscal 2010 is in the bag. PIGS ain't gonna let it happen.

Quantum Nucleonics's picture

Could it be that as buyers go further out in maturity, they are pricing in not so much inflation, as default risk in a heretofore "risk-less" investment? (A sovereign default will, I guess, look like a hyperinflation event.)  I doubt there will ever be a "busted" auction, the Fed and Treasury will always step in to print some $$$.

Species8472's picture

Could be someone with a printing press buying on the sly. OR, a huge pile of money is really scared.


Anonymous's picture

Nice twist on Say's Law.

Alchemist's picture

Once again, you are missing the big picture.  The private sector is delevering and private credit has been collapsing at record speed.  Public borrowing is merely replacing the private credit contraction and aggregate debt levels are not increasing.  As private sector debt rolls off, it merely frees up balancesheet to replace it with Treasurys, which are attractive given the steep curve and the 0% risk weighting that they offer

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