Using Bid to Cover Ratios to Gauge Bond Auction Strength

Interest rate and therefore bond price volatility has picked up in the past eighteen months as Central Banks have tried to rein in inflation, easy money and regain a semblance of control. With this swift move in rates since October we watch to see if the market chases lower yields with stronger bid-to-cover ratios. The bid-to-cover ratio is a simple way to measure auction strength as it balances demand and supply. In the US with debt seemingly increasing by the trillions endlessly, fiscal budgets have blown out and with that treasury bond auctions have expanded.

With bond markets leading markets, it is helpful to gauge them to measure their strength and where you should be investing or avoiding duration wise. That is, for what time period should you be investing.

Hungry Bond Traders

A gauge of auction strength is bid-to-cover ratios. These weaken as bonds sell off, and vice versa. This could be more consequential in otherwise lighter than usual data or news catalysts. It is helpful to also measure the bid to cover ratio for different periods which helps you anticipate the yield curve and therefore future bond auction demand.

The bid-to-cover ratio tells us how much the buyers wanted the bonds relative to how much was offered, in what amounts and for what time period. Everything being equal the higher the ratio, the more meaningful bids there were for each bond re-opening or auction. Traders look at how the current ratio compares to past ratios of the same or similar bonds and to over time series issues. A twelve-month average is a popular comparison.

Caution as always is needed, as bond markets can be very deceptive and should be measured with regard to currency action and hedging around important data releases such as inflation and job data. A higher-than-average ratio typically means a strong auction, and a lower-than-average ratio means weaker demand at the auction. However, the ratio may be distorted because some dealers may bid very low prices away from the market unlikely to win, which inflates the ratio. Ever been to a house auction? For this reason, we use other measures to help confirm a bond auction strength also.

Auction Strength Determinants:

  • Duration
  • Amoun
  • High yield
  • WI level at time of auction (When-Issued)
  • Tail or step through by
  • Bid to cover X vs 12-month average.
  • Directs (a measure of domestic demand) vs 12-month average.
  • Indirect (a measure of international demand) vs 12-month average
  • Dealers (they take the rest) vs 12-month average.

An example of understanding the strength of a bond market auction can be found in The PitBoss auction reports for example:

Sources: Scotia Bank, TC

Note these charts, opinions, news, estimates and times are subject to change and for indication only. Trade and invest at your own risk.

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From The TradersCommunity Research Desk