Everything old is new again

Thom Thompson

Thom Thompson


Photo by Josh Appel on Unsplash

Today, the U.S. Department of the Treasury is picking up where it left off in 1986 with regular issuances of bonds with nominal 20-year maturities. (“Nominal” because the bond will be issued on June 1 and pay out 19+ years later on May 15.) The bonds will pay semi-annual interest. The yield and coupon will be determined through the auction process today. 

Treasury hopes to raise $20 billion by selling 20-year bonds. As we all know, the government is doing this because it needs the money. And it needs more money now than it thought even in early February when Treasury, with the support of the private-sector Treasury Borrowing Advisory Committee, first officially included the 20-year instrument in its financing plans. 

Back then – back when we were still stumbling over “Novel Coronavirus” and “SARS-CoV-2” – the committee recommended a mere $10 to $13 billion auction. According to a Wall Street Journal article on February 5 regarding the industry’s support, “The initial sizing is smaller than what some investors and research analysts were expecting—with estimates as high as $35 billion—but analysts say the Treasury doesn’t have the financing needs this year to justify a larger size.” 

That was three months ago. Now, with Treasury seeking to raise more than $1 trillion this quarter to finance COVID-19 expenditures, today’s $20 billion auction is to be followed by monthly reopenings in June and July that are to raise another $34 billion. The announced  re-opening amount of bonds alone was slightly less than the total amount the industry expected. 

On May 6, when Treasury disclosed the sizes of the newly reborn 20-year, along with other auction amounts, the market did not digest the news with equanimity. That day, 10- and 30-year bond yields rose more than 1/2 and 3/4s percentage point, respectively, according to Tradeweb.   

This $54 billion in new 20-year debt, from now through the end of July, pales next to the Treasury’s whole borrowing program. The government issued $477 billion in bills, notes and bonds in just the first quarter. Treasury is now planning to raise an additional $2.99 trillion in this quarter alone. 

Given the current low interest rate environment and the current preternaturally enormous government deficits, Treasury is looking to adjust its strategy.  Deputy Assistant Secretary for Federal Finance Brian Smith said in his Quarterly Refunding Statement: 

While the initial increases in financing related to the COVID-19 outbreak response were focused on Treasury bills, Treasury expects to begin to shift financing from bills to longer-dated tenors over the coming quarters.  In light of the substantial increase in borrowing needs, Treasury plans to increase its long-term issuance as a prudent means of managing its maturity profile and limiting potential future issuance volatility.

All this portends a lot of trading opportunities among long-term interest rate traders. 

The long end of the yield curve is where the CME’s Chicago Board of Trade Treasury Bond futures used to trade more than the rest of the coupon bearing instrument futures combined. So far his year, the two bond contracts (the 15- to 25-year classic and the 25- to 30-year ultra futures) together have traded 10 million contracts fewer than the 2-year note futures (the 2-year note!!!). 

The new bond will first be deliverable in September 2020. About ten years ago, Treasury issued a 30-year bond with a 4 3/8ths coupon that matures on May 15, 2040, which is the same day as today’s bond will mature. Today’s bond is likely to come out with a coupon at least two percentage points lower. There is $42 billion of the older bond outstanding and there will be $54 billion of the new one. The new bond will have a jarringly different conversion factor. 

New 20-year bonds will be joining the deliverable supply on the classic bond futures contract for a while to come and as a result there may be many cases of two hugely different coupons with identical maturities. Whether any of the tenors are ever in position to be the cheapest to deliver depends of course on cash market conditions, but it could make for some interesting deliveries. 

Although nobody can know how this will play out, we might remember hearing Richard Sandor,  CEO of the American Financial Exchange and chief architect of Treasury futures, talk about the attractiveness of having a little dirt in a futures contract. According to the CME, the cheapest-to-deliver on the classic bond futures tends to be the one with the least time remaining to maturity. If that holds up, in about 4 ½ years there will be two very different May 2040 bonds with different issuances and different ages crowding into the cheapest to deliver window. This could be beautiful. 

The new bond is likewise going to enhance and/or disrupt cash market trading. Until today, there had been a 20-year gap between the 10-year and the 30-year Treasury issues, a very large segment of the bond market and yield curve not to have new issues. This made for what the CME calls “interesting dynamics.” Looking at a half-empty glass, two weeks ago JPMorgan’s head of government bond strategy, Jay Barry, told the Wall Street Journal, “The 20-year is going to cannibalize demand for other securities, particularly the 30-year bond and the 10-year Treasury note.” 

As any bond or note issue ages, it is prone to becoming less liquid and thus more expensive to transact. Now, at the very midpoint of the long end of the yield curve, there will be a regularly auctioned 20-year bond that will itself trade actively, and whose trading will enhance mid-curve pricing and may activate other long-term non-Treasury instruments to trade more actively. According to CME’s Global Head of Research, Owain Johnson, “The launch is likely to enhance liquidity in related products on both the cash and futures side, creating new trading and risk management opportunities for market participants.” These are very happy prospects for CME Group’s Brokertec platform. 


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