Bid-to-Cover Ratio Rose for 2-Year Floating Rate Notes

The U.S. Department of the Treasury introduced two-year FRNs (floating rate notes) in January 2014. An FRN is a debt security. Its interest payment varies. The reference for its rate is a benchmark like LIBOR (London Inter-Bank Offered Rate) or the three-month Treasury yield. The security’s interest payments rise and fall depending on prevailing market rates. As a result, FRNs have near zero interest rate risk.

Mutual funds like the HSBC U.S. Treasury Money Market Fund (HTYXX) and the U.S. Government Securities Ultra-Short Bond Fund (UGSDX) provide exposure to Treasury FRNs.

• The auction was held on December 23, 2015.
• $13 billion worth of FRNs were auctioned in December—the same as the November auction.
• The bid-to-cover ratio rose by 11.9% to 3.5x—compared to 3.1x at November’s auction.
• The high discount margin rose to 0.33%—11 basis points higher than November’s auction. It was the highest ever.

The market demand fell to 40.9% of the accepted competitive bids in December—compared to 47.6% in November’s auction.

The percentage share of direct bidders fell from 3.2% in November to 1.5% in the December auction. Direct bids include bids from domestic money managers like State Street (STT) and American International Group (AIG). Indirect bids include bids made by foreign central banks. They indicate overseas demand. The indirect bids fell. They accounted for 39.4% of the auction in December—compared to 44.4% a month ago.

Due to a fall in the market demand, the primary dealer takedown rose to 59.1%—compared to 52.4% at November’s auction. Primary dealers act as market makers. They take up the excess supply of auctioned securities. They include firms like Morgan Stanley (MS), Citigroup (C), and J.P. Morgan (JPM).

Floaters see their interest rate payments rise in a rising interest rate environment. This is in contrast to regular Treasuries. Their value falls. A rise in the rates would impact the overall bond market—including mutual funds investing in Treasuries and corporate bonds.

In the remainder of this series, we’ll analyze the Treasury bills, or T-bills, auction activity last week.