Bond Auction And Its Impact On Currencies
We just have a quick question here from Amir asking us, what is the significance of bond auctions for currencies?
Now, normally you guys will see in the terminal there is a few previews for upcoming bond auctions that we have from central banks. Now, first of all thank you Amir for the question.
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So looking at bond auctions, it’s fairly straight-forward really. It basically just means that the Central Bank is auctioning off some bonds in order to raise cash. Now during these auctions, the central banks will take…
Let’s take the Federal Reserve for example and they will announce that they are planning to auction certain bills or bonds, basically treasuries with different maturities. So it might be a three-year, a five-year, 10 year, 30 years et cetera and they will also announce how many of each they are making available at the auction.
Now, the buyers, now these are normally your investors, pension funds, hedge funds or banks. They will put in their bids for how many of these offered bonds they would like to buy. Now when the bids for bonds, basically how much people want to buy, are more than the actual offering. For example, the buyers wanted more than the fed was auctioning off, this is usually referred to as an oversubscribed auction and is considered as a successful auction by the Central Bank. Now when the bids are less than the actual offering, it’s known as a under subscribed and is seen as an unsuccessful auction.
The reason why an oversubscribed auction is good, or is seen as successful, is because more demand for bonds means higher prices for bonds being paid and when the bond price rises that pushes down the yield, so that means that the Central Bank will need to pay less, or pay back less in interest on the bonds that they sell.
Whereas an under subscribed auction means that the bond demand will be low which pushes down the price and increases the yield which means the funding costs for those bonds are higher for the Central Bank.
Now, how does this relate back to currencies? Well if all of the bonds on offer are basically sold and it’s oversubscribed, it means that all the buyers of those bonds will need to actually buy US Dollars in order to buy the bonds which should be dollar positive as the exchange into Dollars will obviously push the price for Dollars up and the opposite will be true for an under subscribed auction.
However, it doesn’t always have an immediate effect on the relevant currency, the size of the auction is obviously also important as a very big auction that gets sold out means that there will be more demand for US dollars.
Now during times when the money supply is already low, maybe in a thin liquidity environment like we saw in the Dollar over a couple of weeks back.
A very big over-subscription in a bond auction can have a bigger impact on the currency but it’s usually not something that we’ll expect to see major, major moves in a currency from, but it is good to know that there is auctions in play as it might affect some short-term volatility in terms of the relevant currencies.