Liberty Street Economics

« | Main | »

October 14, 2015

Dealers’ Positions and the Auction Cycle

The aftermath of the financial crisis and changes in technology and regulation have spurred a spirited discussion of dealers’ evolving role in financial markets. One such role is to buy securities at auction and sell them off to investors over time. We assess this function using data on primary dealers’ positions in benchmark Treasury securities, released by the New York Fed since April 2013 and described in this earlier Liberty Street Economics post.

Auctions affect dealers’ positions

Past work has highlighted the importance of the auction cycle in explaining dealers’ positions. Primary dealers are expected to participate in auctions of government debt, and are the predominant purchasers of securities at auction, as discussed in this article in our Current Issues series. A later New York Fed staff report shows the importance of auctions in explaining dealers’ net Treasury bill or coupon security position changes over time across broad categories of securities (for example, all Treasury bills as a group) in the precrisis period, with positions increasing in the weeks including auctions and decreasing in adjacent weeks.

Evolving Role of Dealers

We revisit how auctions affect dealers’ positions here, but for a postcrisis sample period and using more granular data. A past post shows that dealers’ share of purchases at auction has been declining over time. More generally, dealer assets declined sharply during the crisis and have since stagnated, as discussed in this post. Even if dealers are still active purchasers of securities at auction, the extent to which they hold these positions, rather than immediately sell them to other investors, is an open question.

Granular data allow finer analysis of dealers’ positions

While earlier work had to rely on data aggregated across broad buckets of securities, the release of specific issue data allows for a finer analysis. In particular, the New York Fed has been publishing data on dealers’ positions in the most recently issued (or benchmark) coupon securities of a given maturity since April 2013. The data are reported as of the week ending Wednesday, and are aggregated across all dealers. This post focuses on dealers’ net positions, but specific issue data on trading volume, financing activities, and settlement fails are also made public.

Dealers’ Positions in Benchmark Coupons

Dealers in aggregate tend to be net short the benchmark coupon securities. That is, their short positions in the securities generally exceed their long positions. This is because dealers use the benchmark securities to hedge their positions in other securities. For example, dealers often underwrite corporate debt issuance, requiring them to take on long corporate debt positions, and they often hedge the associated interest rate risk by shorting benchmark Treasuries.

The following table shows that dealers’ net positions in five of the six benchmark coupons have been negative (that is, short), on average, since April 2013. Positions in the ten-year note have been mostly negative, averaging -$8.5 billion, but occasionally positive. Positions in the seven-year note have generally been positive, averaging $0.7 billion, but sometimes negative.


Descriptive Statistics on Dealers’ Net Positions in Benchmark Coupon Securities

Dealers’ Positions in Other Coupons

Dealers’ positioning in benchmark securities differs markedly from that seen in other securities. While dealers have been almost always net short the benchmark coupons since data have been released, they have been continually net long nonbenchmark coupons, as shown in the table below. The dealers likely maintain net long positions in the other coupons for market-making or speculative purposes, and likely hedge such positions with benchmark coupons.


Tables2

Dealers’ Positions and Cyclicality

We next consider whether dealers’ positions in the six benchmark coupon securities change over time, and if so, how. The chart immediately below plots positions in the three notes issued around the turn of the month and the subsequent chart plots positions in the three securities issued around the middle of the month. A notable feature of the positions is an apparent cyclicality at roughly a one-month horizon.


Dealers Net Positions in Benchmark 2-, 5- , and 7-Year Note


Dealers Net Positions in Benchmark 3- , 10- , and 30-Year-Coupons

Cyclicality of Positions and Auctions

We know from past work using aggregated data that dealers’ positions tend to increase in auction weeks and decrease in adjacent weeks. Moreover, all of the benchmark coupon securities have been sold on a monthly basis in recent years. It thus seems reasonable to assume that the monthly auctions may be behind the cyclicality in positions noted above. In fact, dealers’ aggregate net positions tend to be highest in the first week in which data are collected for a particular benchmark security, and decline in subsequent weeks, as shown in the chart below.


We next use regression analysis to formally examine the relationship between the auction cycle and dealers’ positions. Specifically, we regress week-to-week changes in dealers’ net positions in the benchmark coupons on dummy variables for the first, second, third, and fourth weeks in which data were collected for a benchmark security. For the first week, the position change is relative to the previously issued security of the same original maturity.

Our results, shown in the table below, confirm that the auction cycle is important to explaining dealers’ net positions in the benchmark coupons. As of the first Wednesday after a security’s issuance, dealers’ net positions in the benchmark securities increase a statistically significant $3.1 billion (for seven-year notes) to $5.9 billion (for three-year notes), depending on the security, relative to their positions in the old benchmark securities the previous Wednesday. In subsequent weeks, dealers’ net positions decline, and by a cumulative amount over the subsequent three weeks that is roughly similar to the increase seen in the first week.


Effects of Auction Cycle on Position Changes, by Security

Aside from statistical significance, the high adjusted R2s of the regressions, ranging from 21 percent for the ten-year note to 43 percent for the five-year note, indicate that much of the variation in dealers’ positions in the benchmark issues can be explained by the auction cycle alone.

In Sum

Dealers continue to be the leading underwriters of Treasury auctions despite their declining share of purchases in recent years. We find that such purchases leave a distinct mark on their holdings of the benchmark coupon securities, with positions increasing in the week of issuance and decreasing in subsequent weeks. The results suggest that dealers continue to play an important role in the intertemporal intermediation of Treasury supply, buying securities at auction and selling them off to investors in subsequent weeks.

Disclaimer

The views expressed in this post are those of the authors and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the authors.


Michael FlemingMichael J. Fleming is a vice president in the Federal Reserve Bank of New York’s Research and Statistics Group.

Collin Jones, a former undergraduate intern at the Bank, is a student at William & Mary.

About the Blog

Liberty Street Economics features insight and analysis from New York Fed economists working at the intersection of research and policy. Launched in 2011, the blog takes its name from the Bank’s headquarters at 33 Liberty Street in Manhattan’s Financial District.

The editors are Michael Fleming, Andrew Haughwout, Thomas Klitgaard, and Asani Sarkar, all economists in the Bank’s Research Group.

Liberty Street Economics does not publish new posts during the blackout periods surrounding Federal Open Market Committee meetings.

The views expressed are those of the authors, and do not necessarily reflect the position of the New York Fed or the Federal Reserve System.

Economic Research Tracker

Image of NYFED Economic Research Tracker Icon Liberty Street Economics is available on the iPhone® and iPad® and can be customized by economic research topic or economist.

Economic Inequality

image of inequality icons for the Economic Inequality: A Research Series

This ongoing Liberty Street Economics series analyzes disparities in economic and policy outcomes by race, gender, age, region, income, and other factors.

Most Read this Year

Comment Guidelines

 

We encourage your comments and queries on our posts and will publish them (below the post) subject to the following guidelines:

Please be brief: Comments are limited to 1,500 characters.

Please be aware: Comments submitted shortly before or during the FOMC blackout may not be published until after the blackout.

Please be relevant: Comments are moderated and will not appear until they have been reviewed to ensure that they are substantive and clearly related to the topic of the post.

Please be respectful: We reserve the right not to post any comment, and will not post comments that are abusive, harassing, obscene, or commercial in nature. No notice will be given regarding whether a submission will or will
not be posted.‎

Comments with links: Please do not include any links in your comment, even if you feel the links will contribute to the discussion. Comments with links will not be posted.

Send Us Feedback

Disclosure Policy

The LSE editors ask authors submitting a post to the blog to confirm that they have no conflicts of interest as defined by the American Economic Association in its Disclosure Policy. If an author has sources of financial support or other interests that could be perceived as influencing the research presented in the post, we disclose that fact in a statement prepared by the author and appended to the author information at the end of the post. If the author has no such interests to disclose, no statement is provided. Note, however, that we do indicate in all cases if a data vendor or other party has a right to review a post.

Archives