Published December 21, 2012
NEW YORK – A dramatic increase in the amount of government bonds that investors purchase directly from the U.S. Treasury Department in its regular debt auctions is reducing the advantage large dealers have traditionally held in the sale process.
The Treasury will not disclose the names of investors who can purchase directly from the government in its auctions but speculation is rife that the participants include an expanding number of the world's largest governments and asset management firms.
BlackRock , the world's largest asset manager, has access to the auctions as a "direct bidder", but does not use it, said Lauren Post, a spokeswoman for the firm in New York. A spokesman for PIMCO, which manages the world's largest bond fund, did not respond to inquiries over whether they have direct bidding access.
Qualified investment funds, insurance companies, banks, and foreign governments may all bid directly in U.S. Treasury auctions, but only the 21 authorized "primary dealers" are required to bid to fulfill their role as market makers in the securities.
"Direct bidders" are showing an increasing presence in the auctions in the last three years, and this week they bought a record share of seven-year notes and the most five-year debt in the auctions in five years.
The shift in the auction procedure is expected to continue, as asset managers increasingly take advantage of the debt sales to buy big positions and leave dealers increasingly in the dark over their purchase plans, while dealers continue to shrink balance sheets weakened by loss making positions taken before the credit crisis of 2007-2009.
"It's becoming more consistent that they are doing that now," said Richard Gilhooly, an interest rate strategist at TD Securities in New York. "They are concealing information and they may think that it might help them get the auction cheaper, because the dealers may bid back thinking the demand isn't there."
Reuters in May reported that China, the largest holder of U.S. Treasuries with more than $1 trillion, has direct bidder status, and market participants surmise other major central banks may also, although this could not be verified.
Japan is close to approaching the size of China's Treasuries holdings, while Switzerland has been dramatically increasing its Treasuries holdings as its central bank accumulates more cash to invest from its foreign exchange intervention against the Swiss franc.
In the auction on Tuesday this week, direct bidders bought 30.4 percent, or $10.62 billion, out of $35 billion in five-year notes, while dealers purchased 37.2 percent, or $12.98 billion.
On Wednesday the bidders bought 23.1 percent, or $6.69 billion in seven-year notes, a record for a those notes. Dealers took 37 percent, or $10.72 billion of the $29 billion sale.
Those recent auctions may have been influenced by year-end demand for low risk assets amid concerns about the impact on U.S. economic growth from the approaching "fiscal cliff" but the results still trail behind a July auction of 10-year notes that stunned dealers.
In that month direct bidders bought 45.4 percent of a 10-year note auction, the largest on record for any Treasuries auction, eclipsing dealer purchases of 14 percent.
LOSING THE INFORMATION ADVANTAGE
The presence of direct bidders in Treasuries auctions has been growing over the past three years, building from a sporadic presence that would involve less than 10 percent of a sale to a consistent attendance that approaches the amount of dealer purchases.
For dealers, the increased presence of direct bidders is making it harder for them to gauge demand for bonds ahead of a sale, and therefore hard to know how aggressively to bid for the debt.
"If you are a direct bidder you're under no obligation to bid, you just have access to go directly to the Fed, which is a complete advantage for you," said Tom Tucci, head of Treasuries trading at CIBC in New York, which is not a primary dealer.
For dealers, "that they are bidding on securities where now they don't see the bids coming, so they are at a disadvantage," he added.
By bypassing a dealer, an investor wanting to purchase a large block of bonds may estimate they can obtain a more favorable price.
Some primary dealers have argued, however, that the shift might cause long-term harm to the auction process, which they say so far has been stable in large part because of support from the Federal Reserve's massive monthly bond purchases.
"The primary dealers are having less information on flows and liquidity. They will take less risk," said Brian Edmonds, head of rates trading at Cantor Fitzgerald, a primary dealer based in New York. "Down the road, you could have sloppy auctions because if the direct bidders step away, primary dealers are not going to fill the void."
For large investors with growing assets under management that need to be invested, government debt auctions are one of the few places they can buy in large amounts with sufficient liquidity, and also without tipping their hand over their positions.
"They are trying to get large size because they have much larger portfolios than before," said TD's Gilhooly.
While asset managers grow their investments, dealers have pared back assets and shrunk their balance sheets, because they are still hurting from risky loans bought and made before the 2007-2009 financial crisis.
Countries which have been active in curbing the appreciation of their currencies in order to help their exporters, may now also have the ability to buy Treasuries in large quantities and direct access may be more appealing, analysts said.
According to U.S. Treasury data released earlier this week, Japan's Treasuries holdings were $1.135 trillion in October, up nearly $130 billion from a year earlier, while Switzerland's U.S. bond ownership grew to $194.4 billion from $143.9 billion 12 months earlier.
China's Treasuries holdings fell to $1.162 trillion in October from $1.256 trillion a year earlier, but analysts have said China has been storing their Treasuries in overseas accounts which are not counted as a part of its official U.S. bond holdings.
(Editing by Clive McKeef)