Introduction
Every government must finance its expenditures with a mixture of debt and revenue. Through debts, governments issue a mixture of short-term and long-term debt instruments to the public. When these debt instruments are being issued, they have an interest rate, one which government will pay the debt holders until maturity. For economists and financial market analysts, the interest rate paid can be used to analyze the government’s creditworthiness and the expected rate of inflation.
Understanding Long Term Bond Auction
A bond in finance is a fixed-income asset issued by an entity to borrow money from investors. Investors get to receive a fixed interest depending on the quantity they purchase. This fixed interest, called a coupon, is usually paid at predetermined intervals until the bond reaches maturity.
Maturity is the duration in which an investor must hold the bond before they can redeem and get their principal back. It is the bond’s maturity that determines whether it is categorized as a short-term or long-term bond.
Long-term bonds are bonds that have maturities of more than one year.
On the other hand, long bonds are bonds with the longest possible maturity that the issuer can issue. For most governments, long bonds usually have a maturity of up to 30 years.
Long bond auction refers to when bond issuers offer the sale of long bonds to the public. It is at these actions where the rate is fixed. This rate is what bondholders will receive for holding the long bonds until maturity.
Bond yield is the return an investor can expect to receive from buying a bond. The bond yield usually comes into consideration when the bond starts trading in the secondary market. We will later see how this yield can be used for analysis.
Here is a list of long government bonds for the developed economies.
- Austria 10-year bonds
- The US 30-year bonds
- Dutch 10-year bonds
- Portugal 10-year bonds
- Spain 50-year Obligation
- France 30-year OAT
- UK 30-year Treasury Gilts
- Germany 30-year Bunds
- Italy 30-year BTPs
The rate attached to these long bonds during auctions can tell us a lot about investor sentiment of these economies.
Using Government Long Bond Auction in Analysis
The rate ascribed to the bond at auction is what bondholders will expect to receive at predetermined intervals until maturity. Comparing this rate with the rates on past auctions, we can form an opinion about the debt situation of the country and the expected rate of inflation by the investors.
For investors, buying a bond is the equivalent of owning an asset that has a predetermined future cash flow. Since it is virtually unheard of for governments to default on interest rate payments or the repayment of principal upon maturity, long government bonds can be said to be risk-free. With this in mind, the only potential risk that bondholder faces is inflation. In fact, inflation has been called the “bond’s worst enemy.”
You see, a rise in inflation means that some percentage will erode the future purchasing power of money. This erosion of the value of future cash flows means that investors must demand a higher interest rate at long bond auctions. At the back of their minds, investors envision that the rate they demand at bond auctions must also include the expected inflation rate. Effectively, higher rates on bonds help mitigate the erosion in purchasing power of their future cash flows.
Source: St. Louis FRED
At the auction, the bond buyers would feel the need to bid for higher rates if they believe that the rate of inflation will remain relatively stable. In this scenario, they can be assured that the purchasing power of their expected cash flows won’t be eroded. So, what does long bind auction tell us about inflation? The rate at an auction will increase compared to the previous auction if investors believe that future inflation will rise. Conversely, the rate at the auction will decrease when investors hold the conviction that future inflation will remain relatively stable.
The other way government long bond auction can be used for analysis is by using the bond yield. For most economists and financial analysts, the yield is the most closely monitored aspect of a bond. The reason for this is because bond yield offers broad information about a country’s debt situation. Here’s the formula for calculation the bond yield.
Let’s use some simple calculations to illustrate how this works.
Say when the bond is being issued, it has a price of $1000 with an annual coupon payment of $50. Remember that the coupon payments are fixed and cannot change; investors can expect to receive this $50 until maturity.
In this case, the bond yield is 50/1000 * 100 = 5%
Now, imagine that the economic situation of a country is worsening, and it becomes increasingly indebted. In this case, the price of the bond will decrease, let’s say to $900, which means that the yield on the bond increases to 5.56%. Conversely, if the country’s economic performance improves, the bond prices will increase, meaning that the yield will fall. In our example, if the price increased to $1050, the yield will decrease to 4.76%.
Impact of Government Long Bond Auction on Currency
Using the yield on the long government bonds published during an auction, we can determine the economic performance. Therefore, when the yield increases, it means that economic performance in the country is worsening. To forex traders, this can be taken as a deep-seated economic contraction, which will make the domestic currency depreciate relative to others. On the other hand, if the yield falls during an auction, it could be considered a sign of economic prosperity. In this case, the domestic currency will appreciate.
Sources of Data
Globally, the central banks are responsible for auctioning long government bonds. Trading Economics has an exhaustive list of global government bonds and their yields. The United States Department of the Treasury, through TreasuryDirect, publishes the data on the US bond auctions.
How Government Long Bond Auction Affects The Forex Price Charts
The recent auction of the US 30-Year Bond was on October 8, 2020, at 1.00 PM EST and accessed at Investing.com. Low volatility is expected upon the release of the auction date.
In the October 8, 2020, auction, the yield on the US 30-year bond auction was 1.578% higher than the 1.473% of the previous auction.
Let’s see if this auction impacted the USD.
EUR/USD: Before Government Long Bond Auction on October 8, 2020, just before 1.00 PM EST
The EUR/USD pair was trading in a steady uptrend before releasing the US 30-Year Bond Auction yield. The 20-period MA can be seen rising with candles forming above it.
EUR/USD: After Government Long Bond Auction on October 8, 2020, at 1.00 PM EST
The pair formed a 5-minute bearish “hammer” candle immediately after the publication of the US 30-year bond yield. Subsequently, the pair traded in a subdued uptrend. The release of the data had no impact on the USD.
The auction of long government bonds serves a vital role in the economy. However, as we have observed in the above analyses, their impact on the forex market is not significant.