(Bloomberg) — Wall Street bond dealers came closer than ever Wednesday to missing out on the Treasury Department’s monthly auction of 10-year notes, marking a steady decline in participation rates in the burgeoning market.
So-called primary dealers — of which there currently are 25 — were awarded a record low 4.2% of the $39 billion auction for their house accounts. Primary dealers are designated by the Federal Reserve and expected to bid in all Treasury auctions.
The rest went to the two other categories of bidders — direct and indirect — sprawling categories that include everything from foreign monetary authorities to asset managers.
It was the smallest primary-dealer award in a 10-year note auction since the department began publishing bidder-participation data in 2003. There have been smaller ones for other types of notes and bonds, most notably Treasury Inflation-Protected Securities, where a 1.5% award in a 10-year TIPS sale in July 2023 holds the distinction of the smallest ever.
For regular Treasuries, the smallest primary-dealer award was 4.1% of a seven-year note in July. An auction of three-year notes on Tuesday also produced a record-low primary dealer award for the tenor.
A small primary-dealer award is potentially positive for the market because it means that the majority of the notes or bonds are in the hands of investors that may be more inclined to hold rather than sell them.
The risk, said John Fath, managing partner at BTG Pactual Asset Management US LLC and a primary Treasury dealer trader from 1993 to 2008, is that the trend disincentivizes bidding by primary dealers. Dealers who fail to win securities in an auction may be forced into the market to buy them at higher prices than they counted on, driving rallies such as the one that occurred after Wednesday’s sale.
“In the next five years at some point there’s a high probability of an auction where dealers get shut out,” Fath said.
“It’s going to cause pain” for traders that are required to bid and set hedges in anticipation of being awarded securities, he said. “It’s going to impact bidding behavior. If I was at Treasury or the New York Fed I’d be concerned about that.”
The decline in primary-dealers awards in Treasury auctions is a long-term trend with several drivers. One is growth in the size of the Treasury market, which has outpaced growth in dealers’ financial resources to warehouse notes and bonds. Another is the growth of passive investing such as index mutual funds and exchange traded funds, which buy Treasuries automatically in order to match the composition of their benchmarks.
Related story: Wall Street Dealers Become Bit Players in US Bond Sales
Until 2008, primary dealers had a virtual stranglehold on the distribution of new US government debt, capturing at least 60% of every 10-year note auction and usually more than 80%.
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