Here's what bond investors need to know about an important statistic
Published: March 14, 2018 at 8:11 a.m. ET
Sunny Oh
Falling bid-to-cover ratio might not be as bearish as it sounds: analysts
Investors are breaking down the auction statistics.
TMUBMUSD10Y
Bond market bears are latching on to a closely watched piece of auction data to argue that appetite for U.S. Treasurys is waning just as the government prepares to unload more than $1 trillion in new issuance in 2018.
But Ian Lyngen and Aaron Kohli, strategists at BMO Capital Markets, in a Monday note, were skeptical that a decline in the bid-to-cover ratio—which measures the amount of bids relative to the amount of supply available in Treasury auctions—portends lower prices and higher yields for Treasurys.
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Investors worried about demand in the face of growing supply point out the bid-to-cover ratio has fallen across all maturities since 2012. The indicator had spiked after the financial crisis, reflecting a surge in demand for haven investments among foreign central banks and financial institutions starved of creditworthy assets.
The bid to cover ratio for 10-year Treasury note TMUBMUSD10Y, 1.876% hovered above 3.00 in 2011, before falling below 2.50 in 2016 (see chart below).
The bid to cover ratio has steadily fallen since the taper tantrum
BMO Capital Markets
But the BMO analysts feel "the trend and the levels support a very different conclusion. For one, the metric tends to be highly cyclical and correlated with the consensus path of yields."
In other words, when yields rose, and prices fell, the bid to cover ratio tended to slip, while when rates fell, and prices rose, the ratio climbed. The gauge was more of a reflection of where investors thought rates were headed and, therefore, not helpful in predicting how investors' enthusiasm for Treasurys would change over time.
"At best, the measure is a lagging indicator of demand (or lack thereof) that the market is already pricing," Lyngen and Kohli said.
For example, the bid-to-cover ratio peaked in 2012 following several rounds of quantitative easing. But the ratio sharply fell when former Fed Chairman Ben Bernanke triggered the so-called taper tantrum in the summer of 2013 when he hinted at a slowing pace of bond purchases, sending yields higher.
In fact, statistics offering a deeper breakdown of recent Treasury auctions paint a revealing picture, they said. They pointed to the hit ratio, which measures accepted bids versus the amount of bids received for each category of participants in the auction.
This hit ratio steadily rose last year among primary broker-dealers, many of whom are tasked with ensuring the success of the auctions by buying up the leftover supply, "implying that while the bidding amounts may be lower, the strength of the bids is improving," the BMO strategists said.
That's significant because dealers will often offer bids well above where the market was trading, which means that they don't represent a real source of demand. The hit ratio can show how many investors are actually showing genuine interest instead of, well, just showing up.
Also check out: One reason to question the most widely used stat on bond auctions
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Sunny Oh is a MarketWatch fixed-income reporter based in New York.