Treasury Auction Cuts Raise Risks for Dealers, RBC Says

The U.S. Treasury’s decision to reduce the amount of debt sold at two- and three-year note auctions may make it riskier for the banks and brokerage firms that are obligated to bid at the monthly offerings.

“Smaller auctions with volatile bids from direct and indirect bidders will make auctions trickier, as dealers deal with the shrinking pie,” said Michael Cloherty, the New York-based head of U.S. interest-rate strategy at the RBC Capital Markets unit of Royal Bank of Canada, one of the 22 primary dealers that trade with the Federal Reserve. “There will be greater swings in the amount available for dealers, which will make them hard” to value the securities before the sales.

The Treasury said today it will reduce the size of the auctions in the next three months with the budget deficit shrinking to the narrowest since 2007. The U.S. will sell $26 billion in three-year notes on Nov. 10, down from $27 billion on Oct. 7. The amount of this month’s two-year auction hasn’t been announced yet.

Primary dealers won the bidding on an average of 49.7 percent of two-year note sales and 48.3 percent of three-year note auctions this year, according to Treasury data compiled by Bloomberg.

The share of winning bids from non-dealers has fluctuated from as low as 41.3 percent to as much as 62.5 percent at two-year note auctions. For three-year auction, the investor classes known as indirect and direct bidders that include pension funds to central banks have purchased as much as 58.7 and as little as 45.4 percent of at the sales.

“As auction sizes shrink, this volatility in direct and indirect bids means the residual left for dealers to bid on swings much more sharply,” Cloherty said.

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