How Yields are Set in Bond Auctions
This post was written by Karl Whelan
We’ve had lots of comments about yesterday’s bond auction, many of them from people confused by headlines about the “heavy demand” for the bonds. If the demand was so heavy, these folks are asking, why couldn’t we have sold the bonds at a lower interest rate? We’ve also had some good responses from people who know the answer but it’s perhaps worth putting the answer on the front page.
Take the €1 billion euro 8-year bond that was issued yesterday. The interest rates that we pay on these bonds are determined in an auction. People submit private bids detailing how much of the debt they want to acquire and what rate they are willing to pay. NTMA want to pay the lowest interest rates possible, so they allocate the bonds to those offering to take the lowest interest rates until they have handed out the full €1 billion of bonds.
Yesterday’s auctions featured €2.9 billion in bids (this is what is meant by the bid-cover ratio being 2.9) and the widely-advertised rate of 6.046% was the highest rate offered that received a full allocation of debt. The business about the “heavy demand” relates to the fact there were €1.9 billion in bids from people who were not allocated bonds. Pretty clearly, however, the existence of these bids can’t lower the rates that we are actually paying since these people weren’t willing to purchase the bonds at lower interest rates.
Also, we don’t know how serious all of these unsuccessful participants were. For all we know, some could have submitted bids at 10%: NTMA don’t release information about the nature of the unsuccessful bids. In the absence of this information, I’d recommend not reading too much into bid-cover ratios.
(Note, for those who want to be picky, I’m deliberately not getting into technicalities about Dutch and non-Dutch auctions and the like but informed commenters can fire away on this stuff if they wish.)