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Authorized for public release by the FOMC Secretariat on 8/21/2020 BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM WASHINGTON, D.C. 20551 October 8, 1974 CONFIDENTIAL (FR) TO: Federal Open Market Committee FROM: Arthur L. Broida Enclosed is a memorandum from the System Account Manager dated October 3, 1974, and entitled "Report on experience with bidding for Treasury bills on a noncompetitive basis." When the Committee, at its meeting on April 15, 1974, approved the Manager's recommendation for noncompetitive bidding in rolling over official holdings of bills, it was understood that the Manager would submit a report on how well the approach was working within 6 months. This memorandum is not being listed on the agenda for the October 15 FOMC meeting in view of Mr. Holmes' conclusion that there has been no significant problem with the new procedure. If any member so desires, however, the subject can be listed for discussion at a later meeting. Enclosure Authorized for public release by the FOMC Secretariat on 8/21/2020 October 3, 1974 CONFIDENTIAL--(F.R.) TO: FROM: SUBJECT: Report on experience with bidding for Treasury bills on a noncompetitive basis Federal Open Market Committee Alan R. Holmes At the April meeting of the Federal Open Market Committee, the Committee approved a change in rollovers accounts. of Treasury bills held by System, Treasury and foreign Since the auction of April 29, submitting noncompetitive tenders rollovers the method of tendering for the Desk has been to accomplish desired bill for the various official accounts. Competitive bids have been submitted to redeem System held issues and to increase the face amount owned by any other customer account. The change was agreed would upon by the Committee with the understanding that I report within six months on how well the new approach was working. The attached memorandum reviews and assesses our experience in bidding for three and six month bills since that time. The most important benefit of the shift in bidding technique has been the ability of Treasury bills in System and to avoid unintended redemptions official customer accounts. analysis of influences on the market An in the recent past suggests that partial allotments to Desk tenders might have been more frequent if the former bidding method had been retained. The growth in System to an and other official account bill holdings average of just under 60 percent of weekly awards would have enlarged the potential complications from bidding misses. in recent months and costs arising Authorized for public release by the FOMC Secretariat on 8/21/2020 2 Treasury bill period since May, as indicated in the attached memorandum, this in rate expectations, the time of volatile comparison with earlier in attributable to various market primarily At rates have been more last May, the change information has probably prior year. appears But, to be factors affecting the Treasury began publish the amounts of maturing issues foreign accounts a few days the change in bidding techniques. than the rather the over held by the to each been helpful to to System and auction. While participants this in determin- ing their auction bids, it may be added somewhat to the volatility of bill rates, discussion a potential of this Based on subject the finally, also of satisfactory Attachment far as to far, the new procedure official holdings that so that was noted in my last April. experience thus significant problem with rollovers development of there has been no for noncompetitive Treasury bills. I should note, I am aware the present procedures are the Treasury and to the market. Authorized for public release by the FOMC Secretariat on 8/21/2020 OFFICE CORRESPONDENCE OCT 9 1974 October 2, 1974 To Subject:Review of experience in bidding for Treasury bills on a noncompetitive basis Mr.Holmes From Sheila Tschinkel This memorandum reviews and assesses experience with noncompetitive tendering in Treasury bill auctions for System and foreign accounts. The shift from Desk bidding on a competitive basis first occurred in the auction of April 29 and the analysis focusses on auction results and market developments since that time. The most significant benefit from bidding noncompetitively has been the ability to avoid unintentional misses on rollovers of System and foreign account issues. A review of several influences on the bill market in the recent past suggests that in the absence of the new technique the frequency of partial allotments could have been greater than previously. Undesired redemptions tend to complicate System open market operations and may be costly to our customer accounts. The publication of the amount of maturing bills held by System and other official accounts a few days prior to the auction has provided useful information to market participants; the impact of this information on market performance is not clearly determinate, although it may possibly have added, at times, to the volatility of bill rates. An earlier examination of auction results over a period when the Desk tendered for bills on a competitive basis showed that its bids tended to exert a very small downward influence on the average rate paid by the Treasury and, as a result, lengthened the spread between the average and the "stop out" rate.¹ While it is 1 Sheila Tschinkel, "Review of the Proposal to Bid for Treasury Bills on a Noncompetitive Basis", memorandum to Mr. Holmes, April 8, 1974. Authorized for public release by the FOMC Secretariat on 8/21/2020 2 not possible to determine auction rates that would have been set if the former bidding method had been retained, the difference between the average and the highest accepted rate has increased since noncompetitive bidding was adopted (see Table I). Analysis suggests that this arose because bill rates were even lower, relative to rates on other instruments, than they had been in the past. While average auction rates have shown more volatility since May, this probably results chiefly from developments in the secondary market where the amplitude of rate fluctuations increased by an even larger extent. Moreover, there was a pronounced increase in the volatility of auction and market rates in the third quarter of 1973,the first of several periods that have been characterized by marked swings in interest rate expectations. Auction method and bill awards The Treasury auctions new bills by first allocating the amount requested by all noncompetitive bidders and then distributing the remainder of the issue to competitive bidders according to price until the total amount of the issue is awarded. The average price is derived by weighting the price of the accepted competitive tenders by the quantity of bills awarded at each price. bidders pay the average price. Noncompetitive The difference between the average price and the lowest price accepted (or the average issuing rate and the highest rate accepted) is the "tail" in the auction. A long tail may indicate limited market demand for bills and upward pressure on bill rates--or a lack of consensus about rates. It may also reflect the low level of bill rates in comparison to other money market rates, such as the Federal funds and dealer loan rates. Authorized for public release by the FOMC Secretariat on 8/21/2020 3 A high cost of financing inventories may influence dealers to scale bids over a broad range of prices. Starting in May of this year, the Federal Reserve Bank of New York began to enter bids on a noncompetitive basis to roll over maturing issues in the System and official foreign accounts. The officers at the Trading Desk still determine a competitive bid for most auctions since tenders to increase the face amount of holdings for any foreign account, or to redeem some of the System's maturing issues, must be submitted with a price. The new method of bidding has assured that desired rollovers are accomplished readily. Secondary market and auction rates Short-term interest rates rose rapidly over most of the period since last May, but have declined in recent weeks. During this period of several months bill rates became more volatile; a phenomenon which appears to reflect market conditions rather than bidding techniques. The increased size of the bill rate fluctuations is evident even when bill rates are averaged over a week and typical day-to-day variability is removed. Table II illustrates this for both changes in auction rates and in weekly average market yields on the three- and six-month issues. Some measures of volatility are provided but their results are not conclusive for a comparison of recent behavior with the past. Weekly changes in market yields and in auction rates on the three- and six-month issues were larger in the weeks after May than in the preceding period of the same length. But the absolute changes in rates and their variance do not appear unusually large in Authorized for public release by the FOMC Secretariat on 8/21/2020 comparison with the third quarter of 1973. It also appears that the volatility of market rates for the three-month issues increased by more than rates set in the auctions. occurred. For the six-month issue, the reverse The variance of the six-month issue, both auction and market yield was below that observed in the third quarter of 1973. This suggests that the change to a noncompetitive method of bidding had less to do with the increased variation in rates than other factors. Both market and auction rates have always been highly responsive to changing market assessments about the course of short-term rates. While there have been significant changes in such expectations over the past few months, the thin supplies of bills in the market have acted to exacerbate rate fluctuations as shifts in supply or demand have a relatively larger impact. Increases in both official holdings of bills and in small investor demand have worked to deplete supplies in the primary and secondary market. Desk tenders for bills(System and customer accounts) accounted for 58 percent of issues awarded in the third quarter of 1974, up from just over 50 percent in the first three months of the year (see Table III). When noncompetitive tenders submitted by the general public are included, the proportion rises to 75 percent between June 30 and September 23, a substantial increase over the 64 percent awarded to the comparable group of bidders in the first quarter. Dealers also reported increases in "odd lot" demand over much of the recent period. Authorized for public release by the FOMC Secretariat on 8/21/2020 5 These purchases further eroded available market supplies as smaller investors tend to hold bills until maturity. The less increased participation of sensitive to yields on alternative investors instruments has, recent years, tended to depress bill rates. the period since May, by concern over that are Over a good part of the relative downward pressure was liquidity pressures corporations which made over intensified on financial and nonfinancial some investors willing to hold bills in preference to other market instruments even at increasingly unfavorable yield spreads. In these circumstances, the difference between the average issuing and the stop out rate could be expected to rise. The frequent depletion of secondary market supplies apparently led dealers to bid at relatively low rates, in comparison to returns on other instruments, for the amounts that they wanted to be sure of obtaining. At the same time, the high negative cost of carry made them reluctant to purchase any more than they were reasonably certain of selling to customers before the payment date--unless they could win them at rates that were well above the auction average and reflected to a larger extent, the level of money market rates. Thus, competitive bidders probably tended to scale bids over a broader range of rates and such behavior worked to lengthen the difference between the average and highest accepted rates. The developments that led to more pronounced rate fluctuations since May made it more difficult for market participants to determine prices on their tenders. Given uncertainties about the size of potential market supplies of bills, the publication of the size of System and foreign account holdings was useful to market Authorized for public release by the FOMC Secretariat on 8/21/2020 6 participants since it provided additional information to use in assessing potential demand from this source. The knowledge that unplanned redemptions of a portion of these large holdings would not occur and that the Desk would bid competitively to redeem issues was also helpful. While unintended misses in Desk bids in the past were rare and often small--there were occasions when the amounts involved were substantial. The secular growth in official holdings relative to total awards implies that the size of unplanned redemptions was likely to increase if the Desk were to continue to bid competitively. The increased volatility of rates suggests that their frequency could also have risen. Consequently, an important benefit of the shift to noncompetitive tendering by the Desk has been the absence of unintended redemptions. At the same time, it is possible that more widespread knowledge of the extent of official participation in the auction has highlighted for some market participant the possibilities for taking advantage of the lessened availability of market supplies--a circumstance that may have contributed at times to increased volatility in bill rates. On balance, however, it is believed that by far the greater influence making for increased volatility has been the underlying market conditions described above, rather than the Treasury's modification in its bidding technique. Authorized for public release by the FOMC Secretariat on 8/21/2020 Table I Treasury Bill Auction Results Six-month issue Three month issue or "Tail" Average Issuing Rate Highest Rate Accepted 7.429 7.425 7.382 7.441 .071 .039 .026 .095 7.666 7.530 7.164 7.315 7.801 7.548 7.198 7.350 .035 7.406 7.615 7.983 7.995 7.778 7.453 7.647 8.019 8.003 7.793 .047 .032 .036 .008 .015 7.371 7.560 7.867 7.819 7.516 7.399 7.568 7.880 7.825 7.526 .028 .008 6.951 7.081 7.018 7.188 6.975 7.109 7.046 7.240 .024 .028 .028 .052 6.747 6.882 6.787 7.081 6.791 6.919 6.808 7.095 .044 7.675 7.920 8.047 8.300 7.722 7.932 .047 .012 .051 .079 7.566 7.637 7.882 8.231 7.584 7.669 7.924 8.248 .018 .032 .042 .017 .032 8.211 .020 8.393 8.084 7.995 8.219 8.409 8.088 8.136 7.618 .008 .016 .004 .141 .028 Average Issuing Rate Highest Rate Accepted Difference 27 7.358 7.386 7.366 7.346 1974 Jan. 3 10 17 24 31 Difference or "Tail" 1973 Dec. 6 13 20 Feb. 7 14 21 28 Mar. 7 14 21 28 Apr. 4 11 18 25 Average 8.358 8.648 8.051 7.857 7.682 8.098 8.379 8.390 8.668 8.074 8.007 7.725 .023 .150 .044 Avg. 7.591 .018 .034 .035 .013 .006 .010 .037 .021 .014 Authorized for public release by the FOMC Secretariat on 8/21/2020 Table I (cont'd) Treasury Bill Auction Results Three month issue Average Issuing Rate 1974 May 2 9 16 23 30 8.909 9.036 8.023 8.197 7.983 Jun. 6 13 20 27 8.300 Jul. 5 11 18 25 7.808 Aug. 8.260 8.177 7.841 7.892 7.702 7.604 1 7.698 8 15 22 29 8.505 Sept 5 12 19 26 Avg. 9.166 8.763 8.846 9.908 9.099 8.185 7.002 8.314 Six month issue Difference or "Tail" Average Issuing Rate Highest Rate Accepted Difference or "Tail" .142 .035 .067 .142 .099 8.796 9.006 8.031 8.440 8.205 8.951 9.022 8.088 8.543 8.254 .155 .010 .057 .103 .049 .055 .028 .008 .099 8.426 8.324 8.175 8.003 8.456 8.337 8.185 8.102 .030 .013 .010 .099 7.848 7.952 7.746 7.631 .040 .060 8.055 8.480 7.576 7.700 8.101 8.527 7.948 7.746 .040 .047 .072 .046 7.785 8.652 8.794 8.901 10.041 .087 .147 .031 .055 .133 8.055 8.660 8.719 8.899 8.134 8.701 9.930 8.966 9.987 .079 .041 .012 .067 .057 9.253 9.154 8.217 7.101 8.385 .087 .055 .032 .099 .071 9.283 8.980 8.203 7.928 Avg. 8.462 9.320 8.996 8.278 7.946 8.515 .037 .016 .075 .018 .052 Highest Rate Accepted 9.051 9.071 8.090 8.339 8.082 8.355 8.285 8.185 7.940 .044 .027 8.731 Authorized for public release by the FOMC Secretariat on 8/21/2020 Table II Auction and market rates Three month issue Six month issue Changes in market rates¹ Changes in auction rates 2 Mean Variance Mean Variance Mean Variance Mean Variance .134 .009 .142 .017 .150 .006 .159 .013 .150 .012 .156 .021 .123 .009 .172 .023 .328 .105 .318 .158 .269 .060 .278 .104 .210 .040 .288 .100 .247 .030 .283 .042 .215 .027 .244 .047 .206 .031 .257 .041 QII .262 .051 .346 .115 .171 .031 .298 .079 QIII .391 .178 .432 .190 .336 .049 .422 .087 11/30/73-4/26/74 .185 .023 .215 .044 .184 .024 .233 .030 5/3/74-9/27/74 .355 .125 .408 .166 .284 .047 .398 .088 1973 QI QII QIV 1974 QI Changes in market rates¹ ¹Five day averages of closing bid prices for weeks ended on Fridays ²Average issuing rate established in weekly auctions on Mondays Both series report absolute changes. Changes in auction rates 2 Authorized for public release by the FOMC Secretariat on 8/21/2020 Table III Desk Tenders* as Percent of Bills Sold 1962 1967 1970 1973 1974 QI 24.52 29.77 32.31 52.87 50.28 QII 21.68 34.99 29.28 51.58 56.37 QIII 21.68 32.33 34.73 50.71 57.78 QIV 23.13 34.32 35.11 50.63 * 12/6/73 - 4/26/74 52.06 5 /3/74 - 9/26/74 54.34 For System, foreign official and Treasury trust accounts Accepted Noncompetitive, System, Treasury and Foreign Account Tenders as Percent of Bills Sold 1970 1973 1974 QI 55.79 59.16 64.04 QII 53.39 60.81 72.73 QIII 54.08 65.29 70.45 QIV 53.72 64.50
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