September 23, 2015 / 11:51 AM / 4 years ago

German bond auction "fails" shine light on bank rules, yield funk

LONDON, Sept 23 (Reuters) - The U.S., German and British governments are finding it harder to sell super-long bonds than at any time in almost a decade as meagre yields deter investors and new regulation bites into banks’ ability to broker this debt.

The end of an almost 30-year bull market in bonds has been called several times in recent years only for forecasters to be confounded by factors from weak economic growth and chronically low inflation to demographics and financial reforms.

But analysis of government bond auctions this year shows demand from market makers - typically investment banks who later sell the bonds to institutional investors like pension and insurance funds - has been steadily ebbing.

All six auctions of the German bond maturing in August 2046 have been technical “fails”, meaning the sum of bids has not matched the amount on offer. It’s the first time since the German finance agency began compiling comparable records in 2007 that every auction of a single bond or bill has failed.

In Britain the “bid-to-cover” ratio for 30-year auctions, which measures the degree to which demand exceeds the quantity of bonds on offer, is lower in the current financial year than any year since the 2008 crisis.

And the bid-to-cover ratio of the last six U.S. long bond auctions is below long-term averages over the period since the reintroduction of the 30-year bond almost a decade ago.

U.S. Treasury data released on Tuesday showed that foreigners bought the fewest 30-year bonds at an auction in early September since March 2010, taking up only $752 million of the $13 billion it offered.

“Banks’ balance sheets are constrained. Putting money towards auctions requires capital, and in this world of constraints it’s more difficult for banks to do so,” said Anthony O’Brien, co-head of European rates strategy at Morgan Stanley.

“Perhaps the days of dealers taking large sizes of auctions are behind us,” he said.


Primary dealers, who are almost exclusively big banks, show up at government bond sales, buy the assets, then sell them to mostly long-term investors. But with new rules limiting how much inventory banks can hold, they are buying less at the auctions.

In the wake of the global financial crisis the Basel Committee on Banking Supervision agreed a global regulatory framework on bank capital adequacy, stress testing and market liquidity risk known as Basel III.

It will be fully in force in 2019, but already many banks are complying with a minimum ‘leverage ratio’ on their non-risk weighted assets for the first time, meaning they now hold more capital against all assets on their balance sheet. Banks say this has made them less able and willing to hold large inventories of bonds bought at auction for any length of time.

This has been a driving factor behind the decline in market liquidity, analysts say, although pullbacks by bond dealers at auctions are mitigated by underlying demand from pension funds and insurance companies seeking stable, long-term returns.

But Jorg Muller, spokesperson for the German finance agency, said the six consecutive fails there were no cause for concern.

“It depends on market conditions on the day when the auctions take place. For each auction, the government usually retains a certain nominal volume which can then be gradually introduced into the market as part of secondary market activities,” he said.

Liquidity is an amorphous concept and impossible to measure accurately. Its scarcity is only exposed in times of crisis. But everyone agrees it is shrinking, and this could dramatically push up the cost of trading, widen bid-ask spreads and make it harder for traders to close out positions.

Buying bonds is no longer attractive to investors either. Years of zero interest rate policy and large-scale quantitative easing from the U.S. and UK central banks, policies which the European Central Bank has latterly adopted too, have rammed bond yields to their lowest levels ever, some of them negative.

After the Federal Reserve kept U.S. interest rates on hold last week, financial markets are now expecting “liftoff” to be as late as the first quarter next year.

The rates strategy team at Royal Bank of Scotland are even more cautious.

“There is now potentially no window for a hike,” they wrote in a recent report. (Reporting by Jamie McGeever; Additional reporting by Richard Leong in New York; Editing by Hugh Lawson)

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