Latest / The Fiscal Policy Podcast with Fexingo: Government Budgets, Stimulus, and Public Spending / How Government Debt Auctions Set the Price of Borrowing
Transcript
- Lucas: The US Treasury borrowed roughly twenty-three trillion dollars last year. That number is so large it practically loses meaning. But the way they do it — the actual machinery — is a weekly ritual that most people never think about. Luna: You're talking about the auctions. The ones where they sell Treasury bills, notes, and bonds to the highest bidders. Lucas: Exactly. Every Tuesday and Thursday, like clockwork, the Treasury announces an auction of a specific security — say, a ten-year note. Investors submit bids, the Treasury sets the interest rate based on those bids, and within hours, billions change hands. It's the single most important mechanism for funding the federal government. Luna: And the rate they set — the yield — ripples through the entire economy. Mortgage rates, corporate bonds, even car loans are all tied to that number. Lucas: Right. So let's take the most recent ten-year note auction, which happened on May 15th of this year. The Treasury offered thirty-eight billion dollars in ten-year notes. Bidders submitted orders for ninety-one billion dollars. That's a bid to cover ratio of two point three nine. Luna: bid to cover ratio — that's the total bids divided by the amount offered. So two point three nine means they got almost two and a half times the demand they needed. Lucas: Exactly. A high bid to cover is a signal of strong demand. But the real story is who's bidding. The Treasury separates bidders into three groups: primary dealers, direct bidders, and indirect bidders. Luna: Primary dealers are the big banks that are required to bid at every auction. They're the market makers. Lucas: Yes. Then direct bidders are institutions like pension funds or hedge funds that bid for themselves. And indirect bidders are foreign central banks and international investors who bid through a primary dealer but are identified separately. In that May auction, indirect bidders took down sixty-three percent of the issue. Luna: That's huge. It means foreign investors, especially central banks, are still hungry for US debt. But there's been talk about China reducing its holdings. Lucas: There has. But the indirect bidder category includes many countries — Japan, the UK, Luxembourg, and others. The Treasury Borrowing Advisory Committee, or TBAC, which advises the Treasury on debt management, noted in its May 2026 report that foreign demand remains robust, even if the composition shifts. Luna: So the auction itself sets the yield. But how exactly does that work? The Treasury doesn't just pick a number. Lucas: No. They use a single-price auction format, also called a Dutch auction. All winning bidders pay the same price — the highest yield that clears the auction. So if the Treasury sets a coupon of four point two five percent on the ten-year note, bidders submit yields they're willing to accept. The lowest yields get filled first. The highest yield that still allows the Treasury to sell all the notes becomes the stop-out yield. Luna: And that stop-out yield becomes the market yield for that security. So every bidder who bid below that yield gets the same yield, not their own. Lucas: Exactly. It encourages bidders to be honest about their true yield demand — if you bid too high, you might not get any securities. In the May auction, the stop-out yield was four point three one percent, about three basis points above the when-issued yield just before the auction. Luna: That tail — the difference between the when-issued yield and the stop-out — can tell you a lot about auction stress. A big tail means demand was weaker than expected. Lucas: Three basis points is considered small. It suggests the auction went smoothly. But not all auctions are that clean. Back in September 2023, a thirty-year bond auction saw a tail of five basis points, which spooked the market because it indicated weaker demand at a critical time. Luna: And that matters because Treasury auctions are the backbone of global financial markets. If an auction goes badly, it can trigger a sell-off in bonds and even equities. Lucas: Right. So the Treasury tries to maintain auction credibility by being predictable. They follow a regular issuance calendar, they communicate any changes through TBAC, and they avoid surprising the market. But there's a tension — the Treasury also wants to minimize borrowing costs over time. Luna: That's where the decision between issuing short-term bills versus long-term bonds comes in. Bills have lower yields, so they're cheaper in the short run. But you have to roll them over more often, which creates refinancing risk. Lucas: Exactly. And in 2025 and into 2026, the Treasury has been issuing a higher proportion of short-term debt — bills now account for about twenty-two percent of total marketable debt, up from around fifteen percent a few years ago. That's what TBAC calls the 'bill share.' The committee's latest report warned that if the bill share stays above twenty percent for too long, it increases rollover risk, especially if short-term rates spike. Luna: So it's a trade-off. Cheap now, but vulnerable later. The Treasury has to balance current interest expense against the risk of a funding crisis. Lucas: And that's where the auction mechanism itself becomes a policy tool. The Treasury can signal its intentions through the composition of issuance. For example, if they want to extend maturities, they'll issue more long-term bonds, even if yields are higher, to lock in rates and reduce refinancing needs. Luna: But that also increases costs today. The Congressional Budget Office estimates that each percentage point increase in interest rates adds about three hundred billion dollars to the deficit over a decade. Lucas: Right. So every auction matters. And the people who watch these auctions closely — the primary dealers, the hedge funds, the foreign central banks — they're parsing every detail. The bid to cover ratio, the tail, the share of indirect bidders. It's like a weekly stress test of global confidence in US debt. Luna: And so far, the tests have been passing. But with debt to gdp near one hundred percent, and the fiscal outlook uncertain, there's always the risk of a 'buyers' strike' where demand suddenly dries up. Lucas: That's the nightmare scenario. It hasn't happened in the US, but we've seen it in other countries. When the UK's mini-budget in 2022 caused a gilt market meltdown, it was partly because investors lost faith in the fiscal trajectory. Auctions suddenly had to offer much higher yields to clear. That's a lesson the Treasury takes very seriously. Luna: Speaking of lessons, this kind of deep dive into how the government raises money is exactly why we do this show. And it's also why listener support matters — it keeps us independent and ad-free. Lucas: Yeah. If you've found our walk through the economy useful, and you want to help us keep doing it without selling your attention to advertisers, you can support the show at buy me a coffee dot com slash fexingo. That's buy me a coffee dot com slash fexingo. No pressure, but every bit helps us keep the conversation going. Luna: And we're grateful to those who have. It lets us focus on episodes like this one, where we can really get into the weeds of a single mechanism that moves trillions. Lucas: So back to that May ten-year auction. The bid to cover of two point three nine was solid, but it was actually down from two point six in the previous auction. Some traders saw that as a sign that demand was softening, especially at the margin. Luna: But it could also just be a normal fluctuation. One auction doesn't make a trend. Lucas: Exactly. That's why TBAC looks at rolling averages. Over the past six months, the average bid to cover for ten-year notes has been two point five, which is in line with historical norms. So no red flags. But watch for a sustained drop below two point two — that would get attention. Luna: And then there's the question of who is buying. In recent years, foreign holdings of US Treasuries have stabilized around seven point five trillion dollars, with Japan still the largest holder. But some emerging market central banks have been diversifying into gold. Lucas: That's true. The World Gold Council reported that central banks bought over one thousand tons of gold in 2024, and 2025 looked similar. But that doesn't necessarily mean they're selling Treasuries — they're just adding gold alongside. The US Treasury market is so deep that even modest selling by one country is easily absorbed. Luna: So the auction system remains robust. But it's not automatic. It relies on a complex ecosystem of dealers, investors, and the Treasury's own credibility. Lucas: And that credibility is earned one auction at a time. Every Tuesday and Thursday, the Treasury puts its debt up for sale, and the market votes with its bids. So far, the vote has been yes. But the margin of approval is something we should all watch. Luna: Agreed. And maybe that's the takeaway — the next time you hear about the national debt, think about the auction that just happened, and the bids that made it possible. Lucas: That's it for this episode of The Fiscal Policy Podcast. We'll be back with a deeper look at how states are experimenting with public banks.