How Yields are Set in Bond Auctions

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.)

68 thoughts on “How Yields are Set in Bond Auctions”

  1. Karl, thanks for the explanation/summary provided.

    I am part of the great unwashed who had assumed that because the demand for our bonds was high, that NTMA could have negotiated a more favourable spread price for the bonds sold.

    Your explanation clarifies the misundertsanding on my part.

    Thanks.

  2. Good posts Karl. Can you answer the question raised by Dan O’Brien in Business Today (Irish Times 22 September 2010):
    “…investors continue to queue up in numbers to buy risky bonds in the primary market. But within days, they start selling them off at a loss in the secondary market, driving the yield even higher. What on earth is going on?”

  3. I think the markets are gaming us. Investors who believe that we will soon be borrowing from the stability fund are quite happy to lend to us at higher rates than we will be paying in a relatively short period of time. In this sense they have a sure bet: our yields are going to fall. They are exploiting the ‘pride premium’: that’s the cost of not going to the fund. That’s the cost of fighting the good fight.

  4. @ KW

    yes / no answer please (!)

    Can the fact that the NTMA met their target sales requirements yesterday be interpreted as a sign of faith by the market in our ability to repay our debt in this regard?

  5. Karl,

    thanks! I think it was very important to point out what is often politically exploited as a success, ‘oversubscription’, such as here:

    Despite the high cost of the debt, the NTMA said the sale of bonds had been a success. That’s because the State’s debt management authority was able to raise the maximum €1.5bn it was seeking, and demand from investors far outstripped supply.

    According to the NTMA there was three times as much demand for four-year bonds as bonds available, and five times as much demand as paper for the eight-year.

  6. @ Aine

    “But within days, they start selling them off at a loss in the secondary market, driving the yield even higher. What on earth is going on?”

    I’m not sure what point Dan is making here. Secondary market and primary market yields (and thus bond prices) have moved pretty closely together. I don’t think there’s a pattern of people buying the bonds in the primary market and then systematically selling them at a lower price later on the secondary market.

    Perhaps he’s just pointing out that yields for Irish bonds have been rising (which depresses the price) so those who have bought in the primary market and sold later have made losses. But I’d hardly imagine that’s a deliberate investment strategy!

  7. @KW & Aine
    I suppose what Mr. O’Brien is getting at is “why would you bother buying for more in the auction when you can buy for less in the market”. It’s a sort of “I’d gladly pay you today for a hamburger tuesday” model…

    I’m guessing one answer might be cost? If you buy in the market, you may have higher fees than if you buy from a primary dealer (who you have an arrangement with) at auction? (Although why and how you’d have a different arrangement, I don’t know; unless the NTMA are soaking up some of the costs?).

    Our friendly posting bond market participants might be able to quosh that one quickly!

  8. An analogy to the CSO points system might be appropriate?
    As an aside, the latest BIS data showed a huge surge in the numbers of banks buying periphery Europe bonds. That could be seen as a signal of confidence ECB won’t allow default.

  9. @ HM

    no difference in costs really – but at least at auctions you know no one is taking a margin, especially given the illiquidity and wide spreads right now where now one knows the “real” price. So in some ways, people consider auctions “fairer”.

  10. “Primary Dealers must be members of the Irish Stock Exchange.

    Primary Dealers are required to be market makers in Irish Government bonds and to comply fully with the obligations arising therefrom (see section 3).”

    http://www.ntma.ie/Publications/2010/BondIssuanceProcedures8Feb2010.pdf

    A failry plain english explation of the role of Primary Dealrs.

    I presume it is still the case.

    So, if the bids are lower than nominal €1.5bn wasn’t raised. €1.5bn nominal was issued. No?

  11. @Eoin

    What is all this about in breaking news in IT website?

    “In an another test, the Government will sell between €300 million and €500 million in a sale of Treasury Bills at 10am tomorrow., an hour before the release of second- quarter economic growth figures. The economy grew 2.7 per cent in the first quarter, expanding for the first time since 2007.”

    Has this been scheduled for some time or has it been hastily arranged today? I haven’t heard of this auction until just now on the IT website, but its not something I follow.

    What is the logic of doing it an hour before the second-quarter GDP figures are released? I can’t quite understand it, but I’m woefully ignorant of how these things work. Will doing it an hour before the figures are released not lead the bond purchasers to assume, rightly or wrongly, that the figures must be bad and that the government are trying to pull a fast one? If they turn out to be bad, nothing gained as bond purchasers will be jumping to that conclusion anyway, surely? If they turn out to be good, is the advantage of waiting until they are published not then lost? Or maybe I have it totally wrong?

    Will the bond purchasers be given the figures at the auction before they are released to the public? Whoever is there selling the bonds on behalf of the government will certainly know. In fact we can be certain that the government allready know them and probably have since early this week. Will the bond purchasers not be just a touch curious and enquire from the government representatives present what the figures are, even though not to be released to the public until an hour later? I know I would if I was splashing out a few hundred million.

    It is all a mystery to me. Interested to know what an expert makes of it.

  12. @ John

    not a surprise move, already scheduled, but its only shortdated tbills (feb and april), so dont think GDP figures should be that much of an issue to people (compared to a longer term buy). Think the GDP release is just coincidental.

    http://www.ntma.ie/Publications/2010/Irish_Treasury_Bill_Auctions_Q3_2010.pdf

    They changed the frequency of the tbills to fortnightly a few months ago – basic idea (i believe) is to hit the market with small amounts of tbills on a very regular basis, kinda make it very “normal” and “regular” for Ireland to be issuing, rather than doing it monthly and having a couple of weeks of speculation before each one. Debateable whether it worked, kinda spooked a few people when this happened in the quiet summer months.

  13. Sorry to ask a very basic question but I can’t find answers on any of the threads dealing with the latest auction or the steep rise in yields from the start of August 2010. Here is the question:

    Given that yields are at record highs and that we have enough cash to last to Q1/2 of 2011 and given current yields are “ridiculous” why are we selling debt at this time?

    Say the 8 year debt we sold yesterday was 1% overpriced, then does that mean that we pay €10m per annum in each of the next 8 years above what we consider a non-ridiculous price. I know we no longer think in terms of millions but why are we apparently throwing away the best part of €100m if we truly think rates are ridiculous and will come down?

    A basic question and my apologies if it has been addressed elsewhere.

  14. @ Jagdip

    ever had one of those dodgy cars that you’re worried won’t start again if you turn the engine off or let it stall? For that read the NTMA and funding.

    One of the key strengths for Ireland at the moment has been our buffer of 20bn in cash, and the NTMA clearly wants to maintain that. The cost of servicing yesterdays issue is minimal (per issue). Its the cumulative cost which may eventually become more problematic. Eventually they may step back from the markets, but it will be ever tempting to keep doing one more issue to try to retain a sense of normalcy. The fear is that stepping back from the markets will be seen as a sign of weakness (“is it just the yield or are they worried about demand as well??”)

    One of the problems with attracting buyers for our debt over the last couple of years has actually been our previously ridiculously successful budgetary/fiscal position – we issued hardly anything into the market between 2002-2007**. As such, we had no ‘natural’ investor base. In contrast, some countries in the EZ, notably Italy, have run deficits for so long (forever?) that they have a very large domestic investor base.

    **(this is also the reason the likes of Anglo were able to issue bonds so cheaply – if you wanted to get exposure to Irish bonds, you had to buy financials as there was so little sovereign!)**

  15. @Eoin

    Thank you for that and a recognisable analogy – once had the German supercar and indeed leave it for a few months and the battery was knackered and the fuel system needed to be cleaned.

    But a 1% interest premium (from acceptable to ridiculous say) equates to €80m over 8 years on €1bn of dbt. So we paid €80m yesterday for nomalcy?

    And our borrowing costs will come down in October from “ridiculous” when Anglo’s cost is clarified and NAMA has moved a step closer to completing acquisitions.

    So we paid an €80m for normalcy in these circumstances? Isn’t that crazy?

  16. @Jagdip
    In addition to what Eoin has been saying, there’s a fair amount of short-term debt, so it makes sense to roll this into longer term, even as more short-term is issued. That way you lengthen the average duration of the debt and reduce the likelihood of a pile up.

  17. @ Jagdip

    the problem is simply that they do no know what will happen if they dont issue for a month or two and then come back – in these markets its a complete guess as to what happens in, say, December after missing Oct and Nov. If sentiment got worse and the markets just decided to stay away, the game would be up. At the very least, can you imagine the amount of attention the market would be paying to that auction? And the buffer would be 3bn lower at that stage as well. So while i agree their policy is debateable, and i’d imagine the NTMA have considered stepping back, i dont think its fair to say its crazy, simply a more certain strategy than the market potentially closing up on them. What they could consider doing is reducing down the amount and tenor of the next auctions – say 1bn focused on 3-4-5-6 year rather than bigger amounts and longer dates.

  18. @Eoin,

    Thanks again but if I understand the circumstances correctly we have enough cash to fund our deficit for six months to the end of Q1 2011. We are given to understand that the reason for elevated interest rates is Anglo (and the cost of bailing out the banks generally). Patrick Honohan is going to put his reputation on the line next week with a final estimate of Anglo’s costs, and NAMA’s acquisitions should be nearly 50% complete in 2 weeks with crucially a steer on the discounts for smaller-scale developers.

    But still we cannot afford to wait for a month and the cost of yesterday’s issue is at least €80m over 8 years if you conservatively assume we are paying 1% “over the odds”. And that pretence at normalcy is worth €80m and markets (which I understand are a small number of fairly intelligent bond investors) are impressed at this display of strength?

    Again I know €80m is tiny compared to the vast sums being thrown around but it would pay salaries for 166 deputies for 5 years for example. it’s still a considerable sum.

    But if you say that’s how this small market works, I suppose fair enough – it just seems strange (or indeed crazy to me).

  19. @hoganmayhew

    So on side of the scales you have short-term debt maturing that needs to be refinanced and if you replace that debt with longer term debt you avoid the risk of markets abandoning our debt but on the other side you have record interest rates (and the interest rates rise as the term increases so 6-month debt has a low annual interest rate whereas 10-year debt has a high 6%+ annual interest rate).

    Why are we locking into long term (record) rates when in a couple of months the hope is that our situation is normalised with increased certainty in the cost of the bank bailout and the NAMA haircuts.

    Sorry again, doesn’t make sense to me.

  20. @Jagdip Singh

    Acknowledging my own ignorance in this area – I view this as signalling that NTMA are on top of things – were NTMA to pull out of a scheduled auction then the PERCEPTION changes and the rumour mill would go into overdrive looking for reasons ……… and the self-promoters would be on every Biz channel and Op-Ed piece that the Island is sinking into the debts of the North Atlantic ……….. well worth €80 million at the mo to keep ‘Leave the Euro’ Mac and ‘Bring in the IMF’ Man_of_Year out of the headlines for a while: C’mon – it would simply pay off the loans of Shawnee’s quads ….. if he has them. We’re liquid for the mo ……

  21. @ DoD

    perception would indeed (potentially) become reality. I note D-Mac was tweeting away at the weekend that “Yesterday’s bond carnage means the markets are shutting down for us”.

    Obviously yesterday’s auction would suggest otherwise – indeed everyone is now saying the we should have gotten the markets to accept a lower yield!!

  22. @David

    You may well be right – this is not my area at all. But the thought that we just paid sophisticated and pretty smart bond investors €80m yesterday (and I calculate that simplistically at say a 1% interest premium from “normal non-ridiculous” rates over 8 years on €1bn) to maintain normalcy and perception seems just crazy to me when in a few weeks time we are supposed to have addressed the core reasons for our elevated yield rates.

  23. @Jagdip Singh
    The choice is between expensive debt and maybe no debt.

    Also having a good cushion of cash is probably keeping our rates lower than they would otherwise be.

    A few missed months with the maturities in the Q1 would half the €20bn and once the market knows you can’t miss many more auctions they will punish you on the price.

  24. @D_E

    That’s fair enough. But why the statements about bank bailout uncertainty then when that should be far clearer in days?

    Doesn’t spending €80m over the odds yesterday (using the assumptions above) just show that the record interest rates are not just down to bank bailout uncertainty?

  25. @Jagdip Singh

    matter of scale – the quarantee to Anglo-Irish could run [pick a number between 30 and 45 billion] + factor in the lost productive wealth [beyond me poor head … but lets say factor of 3: 90 to 135 billion] and €80 mere million looks like sweety_money for one of Shawnee’s cousin’s kid …..

    @Eoin

    Yes. This stuff is interdisciplinary ……… btw think Lewis got some of his style from Galbraith ……….

  26. @David O’Donnell

    Yes, to what?

    @Jagdip Singh
    “Doesn’t spending €80m over the odds yesterday (using the assumptions above) just show that the record interest rates are not just down to bank bailout uncertainty?”

    I think the market has made up its own mind on the embedded losses within Anglo.
    So I’m not sure a statement from the FR, notwithstanding his excellent reputation, will change that opinion all that much.
    Unless of course they outline in great detail how the number is derived and the assumptions used are credible.

    The best thing they could do would be to ask the NAMA valuers to go through each of the non-NAMA Anglo loans and come up with an estimate of the real value because the provisions just don’t look credible at the moment.

  27. @Jagdip
    Well, even if we somehow keep the perception that we are doing the right thing, we are going to suffer shockwaves from elsewhere. The Portugese bond auction did not go as well today as ours, they accepted only at the lower end of bids. Another country going to the Fecked Sovereign’s fund would probably bring ruinously high yields for a time.

    I have to say, I don’t like it either. We’ve been carrying 20 bn of cash around for the past year and a half. Mr. Lenihan tells us that the average yield we are paying this year is 4.2%, the same as last year. Over 18 months on 20 bn, I make that 1,260,000,000.

    Now, I am a little confused. Perhaps I misheard the good Minister. He clearly wouldn’t have his sums wrong, but on the 91,400,000,000 of GGD there was at the end of last year, 2,500,000,000 was paid in interest, according to the NTMA, or 2.7%

    Enlightenment anyone?

  28. @hoganmahew
    “Now, I am a little confused. Perhaps I misheard the good Minister. He clearly wouldn’t have his sums wrong, but on the 91,400,000,000 of GGD there was at the end of last year, 2,500,000,000 was paid in interest, according to the NTMA, or 2.7%

    Enlightenment anyone?”

    No enlightenment I’m afraid, just more questions.

    Isn’t the GGD over €105bn?

    €84.5bn in long term bond
    €5.5bn approximately in T-bills ad short term debt
    €11.5bn in retail debt (Based on the latest funding summary and instruments comprising debt on the NTMA website as of June10 and Dec09)

  29. @ Hoggie

    per NTMA website, national debt was “50.4 billion euro at end 2008” and “75.2 billion at end of 2009”. However, coupons are paid annually on most or all of this (sometimes a short starting coupon), so probably makes more sense to put the bulk of the 2.5bn interest cost as the cost of the 50.4bn in debt (ie no, or little, actual interest cost “paid” on the additional 24.8bn in fresh debt). Sound more reasonable? From an accounting point of view its not great, but from a cashflow point of view it might make sense?

  30. @ DE

    National Debt = nominal value of central government debt outstanding minus Exchequer cash balances. It was 75bn at end of 2009. This is what the 2.5bn figure relates to (and as explained above, only really effect the end 2008 figure).

  31. @ DE

    dunno how the accounting works – but they specifically refer to the 2.5bn as the cost on the “national debt”, and they say the “national debt” at end of 2008 was 50.4bn and end 2009 as 75.2bn. Not sure if the short terms debt (which makes up the bulk of the difference) is somehow classified somewhere else – because its really a “buffer” rather than real “funding”, does its cost sit somewhere else?? (in fairness, up until the last few months the ST debt would have probably “cost” nothing in that it could be reinvested in central banks or AIB/BOI at close to cost anyway).

  32. I’d like to take this opportunity to thank all of the learned economists on this site who so generously donate their time to informing the public debate on these important issues. This site is a wonderful resource.

  33. @ DE

    ooh, think i found it. Figures are 2008/2009:

    Short term debt costs: 254/615(m)

    Interest received from central banks/other banks 368/319 (m)

    Its not a perfect equation (havent included national savings scheme – another 250mio)

  34. @Eoin
    Cheers Eoin. Where did you find that?

    So the excess cash is placed with the CB and other banks. What does the CB do with the cash? Would some of this excess cash have been lent to Anglo through the MLRA?

    What other banks would the NTMA deposit the cash with?

  35. @DoD/ Jaqdip
    “..were NTMA to pull out of a scheduled auction then the PERCEPTION changes and the rumour mill would go into overdrive looking for reasons …”

    Surely the obvious reason for pulling out of a scheduled auction is the one Jaqdip has given – i.e to save 80m. Sorry but your and Eoins arguments just seem like perverse doublethink. Do we just throw rationality out the window

  36. @ AMcGrath

    we seem to have given a reason, backed with some arguments. You seem to just be suggesting it doesn’t make sense. Eh, want to elaborate why they did go ahead with it?

    @ DE

    http://www.ntma.ie/Publications/2010/NTMAAnnualReport2009.pdf

    Not sure how it works when the NTMA gives money to the CB, but when a normal bank does it really goes to the ECB. Not sure if or how it would differ when the NTMA are involved (i assume its the same). Imagine some of the rest (if there’s 20bn there i’d say only 1bio or so in total) of it goes short term to AIB, BOI and ILP.

  37. @AMcGrath

    …. perhaps the NTMA believe in protecting the solvency of the country (-; and they are not doing a bad job on sovereign liquidity/cash-flow in somewhat difficult times …….. btw they have a world class reputation …

    As to your ‘perverse’ ‘doublethink’ & ‘rationality – I simply have neither the time nor the inclination to engage ……. and you are, of course, perfectly entitled to your opinion on the rationality of saving a penny and losing the rest of the pound.

  38. Bond. Eoin Bond

    “kinda make it very “normal” and “regular” for Ireland to be issuing,”

    Or if you like.

    Kinda makes it very normal for Ireland to get desperate enough to feed off the short end.

    Knowing that the EU/ECB is not yet ready to pull the plug.

    After all, the German and French banks are not yet solvent.

    Though it is a mute point whether they will or will not become solvent.

    I wonder did …

    Credit Agricole Corporate & Investment Bank

    Deutsche Bank A.G. (Frankfurt)

    HSBC France

    Societe Generale S.A.

    UBS Limited

    Buy any of that Irish issue.

    Which of those banks, all Primary Dealers, would go bankrupt overnight if Ireland said.

    We’re not playing anymore.
    There comes a point when bailing out German and French banks is not in the interest of the Irish people.

  39. @Greg

    ‘There comes a point when bailing out German and French banks is not in the interest of the Irish people.’

    There comes a point when bailing out a certain Irish bank is not in the interest of the Irish people.

    7_of_9 says Hi!

  40. A bit off-topic, but I have been wrestling with the following question: how is it that 8y Irish bonds have been sold @ 4.5%, whereas the 10y yield is reported at 6.5% ish. It feels like these measures aren’t on the same “scale”, otherwise they imply an 8y2y forward rate of around 15%.

    What am I missing?

    Btw, I’m a long-time reader here and really appreciate the quality of the blog + comments – thanks.

  41. These are the last gasps of the money machine. The sovereigns are now playing games to drive down their fiat make believe currencies.

    There is no actual information available, so there is no real market.

    The pretensions of those who erected economics as a science are close to being exposed.

    The Irish taxpayer will pick up the tab, so no worries! Should be easy, once the CT rate is 30% …….. and land taxes are 3% pa of market value.

    This whole post is like analyzing the Jacquard patterns in the textiles of the deckchairs on RMS Titanic!

    We have Euro institutions “buying” and then stuffing into pension funds run on OPM. As the rate of increase in repayment interest suggests, there will be a time when it will make no sense to “borrow” more by “selling”.

    Then, will there be an illumination over the Dail? Blue beams? A fast budget followed by an election? But still no deficit reduction, because there is a zombie government with one policy: depend upon the money machine!

  42. @D_E & @Eoin
    Thanks for the continuing detective work.

    I should have given some dates – the figures I gave were for 2009 – see here: http://www.ntma.ie/NationalDebt/compInstruments.php The cash balances that the NTMA holds are used to offset the GGD figure to arrive at the national debt figure.

    I can’t see that the interest paid (that the NTMA say was 2.5bn on the national debt of either 75 bn or 91.4bn GGD). Even if we take 2.5 bn being the net interest rate on 75 bn of net debt, that’s 3.3%, so we’ve seen the average interest cost rise from last year.

    But looking at the NTMA accounts (thank @Eoin, I’d forgotten they were there), we see that the 2.5bn is a net cost on the GGD, so giving us an average interest expense (i.e. stripping out costs and sinking fund payments and leaving in interest income) of about 2.7%!

    As to where the cash balances sit and who sits them there, while there isn’t clarity on this, the suspicion must be that the continuing institutional run on the banks is resulting in increasing holes in the deposit base that have to be filled.

  43. @DoD
    Can’t quite see why you feel it neccesary to defend the reputation of the NTMA. I’m sure that body is as excellent as you claim. Is ther something I have posted which hints otherwise – I can’t find it.
    Maybe you have some inside knowledge as to their rationale and why it coincides with your view, as opposed to my – pure guess I admit – that maybe they don’t feel that the they would get a better deal later. I just thought Jaqdips argument made sense. Your’s just didn’t appear to. Are you seriouly suggesting that they are driven by a fear that David McWilliams (and others) will spread nasty rumours?
    If you can show that this is NTMA reasoning well I guess that is a different ballgame – and maybe then I would start to question their sanity.

  44. @ Hoggie

    is it not as simple as this – 2.5bn is the actual amount paid OUT, as opposed to just accrued? Given that only 50bn in national debt (which the 2.5bn specifically refers to) was in existence at 31/12/08, and given that bond coupons are typically annual, any new debt in 2009 would not have a physical interest payment until 2010. Sooooooo, the 2.5bn mainly (though not all) relates to the 50bn in outstanding debt at end 2008?

    @ GJH

    the coupon on the 2018’s is 4.5%, but they were sold at 90cents, so that gives an actual yield of 6% (you are receiving an effective 5% coupon (ie 4.5/90) but you will also receive 100 back at maturity vs 90 cost, so you have to account for that 10 cent pick up as well).

  45. @ AMcGrath and Jaqdip

    ” that maybe they don’t feel that the they would get a better deal later”

    Just because the some industry economists and Brian Lenihan say that they expect that our 10 year bond yields will head back towards “normal” levels does not mean that the NTMA can take it as gospel or should at least hedge their bets.
    They should and do act in a more prudent way.

  46. @Eoin
    “is it not as simple as this”
    I get what you’re saying. I’d forgotten about the oul lag.

    Short-term and commercial paper would be rolled in 2009, but new issues might not be. So it is equally bogus to say that we are paying this year the same as last year since it will be next year before we start paying for this year? Who’s on second base…

  47. @Greg

    The Borg have no interest here (I have this from a reliable source; they are as terrified of the place as the eymm_F)

  48. @ GHJ

    with a fresh issue they would (or fairly close to) – but this auction was tapping an existing bond which already has a coupon of 4.5%. We only have 10 or so bonds in existence (one per year basically) so that each bond has a good bit in issuance (6-7bn min) and is reasonably liquid.

Comments are closed.