Why demand is rising for 3-year Treasury notes

Phalguni Soni - Author

Nov. 20 2020, Updated 5:08 p.m. ET

Three-year Treasury notes auction held on October 7

The U.S. Department of the Treasury holds auctions for three-year Treasury notes (or T-notes) each month. Three-year notes are at the short-end of the yield curve. As a result, they’re more sensitive to short-term rate movements. Exchange-traded funds (or ETFs)—like the iShares 1-3 Years Treasury Bond Fund (SHY)—have holdings in three-year T-notes.

Auction highlights

  • The auction size was set at $27 billion. It didn’t change from the last three auctions.
  • The issue’s coupon rate was the lower at 0.875%—compared to 1% in September’s auction.
  • The high yield was also lower, at 0.997%, versus September’s yield of 1.066%.

Demand analysis

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The bid-to-cover ratio came in at ~3.4x. This was the highest level since February 2014. The ratio is an important demand indicator. It’s the total value of bids received divided by the value of securities on offer. A higher ratio implies higher demand and vice versa. The bid-to-cover ratio came in at ~3.2x in September. The ratio averaged ~3.3x in all auctions held in 2014.

Market demand falls on lower direct bids

Market demand consists of direct and indirect bids. Indirect bids include demand from foreign central banks and agency and supranational borrowers. Direct bids include bids from domestic money managers—for example, American Insurance Group (AIG). AIG is part of the SPDR MSCI World Quality Mix ETF (QWLD). AIG issued $750 million in debt last week. We’ll discuss this in Part 5.

October’s auction saw slightly lower market demand at 53% of the competitive accepted bids. This was down from 53.4% in September. This was due to a lower percentage of direct bids. Direct bids fell from 20.3% to 17.4%. However, indirect bids were higher at 35.5%. They were up from 33.1% in September.

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As a result, primary dealer allotments increased to ~47% of the competitive accepted bids—from ~46.6% in September’s auction. Primary dealers act as market makers for the auctioned securities. They have to bid at auctions. They include financial institutions like JPMorgan (or JPM). A higher dealer takedown implies lower market demand and vice versa.

Auction analysis

Lower domestic market demand reflected market wariness over the Fed’s release of September’s Federal Open Market Committee (or FOMC) meeting minutes. The minutes were due to release on Wednesday, October 8. The minutes revealed detailed discussion among FOMC participants on important policy topics like rates increases and money supply.

Three-year yields are more sensitive to changes in short-term rates increases because they have shorter tenors. You can read a detailed analysis of the minutes in “Must-know: Updates from the Fed’s September FOMC minutes.”

Overseas bidding for U.S. Treasuries (TLT) got a boost on flight-to-safety flows on two reports that released last Tuesday:

  • An International Monetary Fund (or IMF) report flagged global growth concerns—read more in Parts 7 and 8.
  • Germany’s gauge of industrial production fell 4% month-over-month (or MoM) in August. This is the lowest level in over five years. This led to market fears of a recession in Germany. Germany is the biggest economy in the Eurozone.

We’ll discuss secondary market demand in Part 8 of this series.

Ten-year Treasury notes auction

In the next part of the series, we’ll analyze the key highlights of last week’s auction for ten-year Treasury notes (IEF).


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