Must-know: Analyzing the 5-year Treasury notes auction

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Sep. 9 2014, Updated 12:00 p.m. ET

Five-year U.S. Treasury notes auction held on August 27

The U.S. Treasury holds monthly auctions for five-year Treasury notes (or T-notes). Stock and bond (IEF) (TLT) market participants watch the five-year T-note auction. The slope of the yield curve is determined by the difference between five-year and 30-year Treasury yields. The yield curve usually slopes upwards—yields go progressively higher as the maturity increases.

Exchange-traded funds (or ETFs) like the iShares 3–7 Year Treasury Bond Fund (or IEI) and the Vanguard Total Bond Market ETF (BND) have holdings have holdings in five-year T-notes.

Five-year T-notes auction highlights

  • The auction size was set at $35 billion—unchanged from July’s auction.
  • The issue’s coupon rate was also the same at 1.625%.
  • The high yield for the August auction was lower at 1.646%—compared to July’s yield of 1.72%.

Demand metrics

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The bid-to-cover ratio for the auction came in at 2.81x. It was unchanged from July’s auction. Primary dealer bids came in at ~37% of total accepted competitive bids. This was higher than July’s ratio of ~26%. Primary dealers act as market makers. They clean up excess supply at Treasury auctions. An increase in dealer bids indicates lower market demand.

A lower percentage of direct bids caused the higher dealer uptake. Direct bids were down to ~10%—compared to ~26% in July’s auction. Direct bids include bids from domestic money managers—for example, the State Street Corporation (STT). STT is part of the SPDR S&P 500 ETF (SPY).

However, indirect bids were higher at ~53%—compared to July’s ratio of ~48%. Indirect bidders include overseas bidders like foreign central banks. Overseas demand spiked due to a fall in European sovereign bond yields. This made U.S. Treasury yields more attractive for investors.

Key implications of the five-year Treasury notes auction

After the auction, yields for five-year Treasuries declined by three basis points to 1.65% from 1.68%. The spread between five-year and 30-year Treasuries flattened to 1.46% on August 27. This is one of the lowest levels since January 2009. As mentioned in Part 3, the flatter curve was driven by demand-side factors—not recessionary expectations.

In the next part of the series, we’ll analyze the monthly auction for two-year Treasury notes.

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