Dollar holds CPI gains after soft US auction: how bond auctions work

The US dollar held onto its inflation-driven gains after a weak sale of US government debt added to pressure on yields. According to investingLive, the US Treasury sold $42 billion of 10-year notes at a yield of 5.02%, an auction it graded "D+" and called "a little soft".

This came on top of Tuesday's hot inflation report. Investing.com reported that the dollar jumped as hot CPI and comments from Fed Governor Waller brought a "supersized" Fed hike into play. Since our last article, investingLive's Americas wrap added that Fed officials Bowman and Schmid flagged "work to do" on inflation, and that Bank of Canada minutes showed a possible need to hike further. For more on the Fed speakers, see our sister site's report on Fed hawks and the soft 10-year auction.

Elsewhere, investingLive reports that Japan's Reuters Tankan for manufacturers rose to +27, the highest in over five years, which it says could support expectations of Bank of Japan tightening. In Australia, investor home lending fell 32% in the third quarter, which investingLive calls a modest headwind for the Australian dollar. In the latest ECB reference rates, from 10 November, USD/JPY fixed at 158.18 and AUD/USD at 0.6904. A fixing is one snapshot per day, so it may not show every move that day.

What is a government bond auction?

Governments borrow money by selling bonds. A bond is an IOU: you lend money now and get interest plus your money back later. The US Treasury sells new bonds through regular auctions. Big investors submit bids saying how much they want and the lowest yield they will accept. The yield is the annual return the buyer earns.

The Treasury fills the sale starting with the lowest yields. The yield on the last bid it needs to accept is the high yield. If demand is strong, the government borrows cheaply. If demand is weak, it must offer a higher yield to sell everything.

Traders watch three numbers:

• Tail: the gap between the high yield and the market's expected yield just before the auction (the "when-issued" or WI level). A positive tail means buyers demanded more than expected.
• Bid-to-cover ratio: total bids divided by the amount sold. Higher means more demand.
• Buyer mix: how much went to foreign and other investors versus dealers, the banks that must absorb what others do not take.

A worked example

Here are the numbers investingLive reported for this auction.

Tail. The WI level was 5.01%. The high yield was 5.02%. 5.02% - 5.01% = 0.01 percentage point, which is 1 basis point (bp). One basis point is one hundredth of a percent. On average these auctions clear 0.6 bp below the WI level, so this one was weaker than usual.

Bid-to-cover. 2.46 x $42 billion = $103.32 billion of bids. At the average ratio, 2.60 x $42 billion = $109.2 billion. So bids were about $5.9 billion lighter than normal.

Dealers. 9.8% x $42 billion = about $4.1 billion left with dealers, above their average share of 7.45%. That is another sign of softer outside demand.

Why it matters for new traders

When an auction is weak, the government pays more to borrow, and yields can rise across the market. Higher US yields can make dollar assets more attractive to hold. That link is one reason forex traders watch auction results, especially in a week when inflation data has already pushed rate-hike bets higher.

Auctions are scheduled in advance, so you can know when they land. But one auction is one data point. Its effect on currencies depends on what else is moving, such as central-bank comments and inflation data. You can follow the dollar on a DXY chart or watch USD/JPY, a pair often sensitive to US yields.

Key terms

• Bond: a loan to a government or company that pays interest.
• Yield: the annual return on a bond, in percent.
• Basis point (bp): 0.01 percentage point.
• Tail: high yield minus the pre-auction expected yield.
• Bid-to-cover ratio: total bids divided by the amount sold.
• Dealers: banks that take up bonds other buyers do not.