‘The market is just dead’: Investors shun 20-year Treasuries

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Investors shun US 20-year government bonds, distorting US Treasury market by $23 billion.

Demand for the 20-year government debt security since its reintroduction in 2020 has been so weak that its price is far out of sync with the rest of the market and is harder to trade. Price swings and lack of liquidity have made it even less popular with conservative long-term investors, such as pension funds, who would typically be its natural buyers.

“The 20-year part of the market is just dead,” said Edward Al-Hussainy, senior interest rate strategist at Columbia Threadneedle.

Difficulties in stimulating investor demand for 20-year Treasuries could ultimately spread to other parts of a market that form the bedrock of global finance, said Mark Cabana, head of rates strategy. Americans at Bank of America.

Due to lackluster interest, the 20-year stands out as the cheapest conventional bond in the Treasury market. The low price means that 20-year Treasury yields are higher than their 30-year counterparts, at 3.37% and 3.1%, respectively. Generally, bonds with longer maturities offer higher yields to account for the greater risks associated with holding debt that matures further in the future.

Cabana said the higher yields needed to convince investors to hold 20-year Treasuries ultimately cost taxpayers by increasing the government’s cost of borrowing.

“They’ve discontinued the 20s once in the past,” he said. “And why did they interrupt it in the past?” Because they felt it was not beneficial to the taxpayer. It was not about getting the lowest cost to the taxpayer of financing, and that argument can easily be made today. »

The spread between 20- and 30-year yields widened earlier this month as the Federal Reserve tightened monetary policy sharply in an effort to counter soaring inflation. Shrinking the size of the Fed’s $9 billion balance sheet only exacerbated these problems as the market was left with more supply to absorb.

The relaunch of the 20-year bond, which the Treasury had shelved for more than three decades due to a lackluster appetite, was part of a larger plan to dramatically increase government borrowing through longer-term debt with the aim of locking in lower rates for an extended period of time.

“It never really had traction because [the 20-year] traded so poorly compared to others [long-dated] instruments, and the liquidity is terrible,” said Bob Miller, head of U.S. multi-sector fixed income at BlackRock. “Then you kick off a nine-month period where the Fed has pivoted and is intentionally very aggressively trying to tighten financial conditions. . .[and]which exacerbated the structural weaknesses that were already evident.

The 20-year should remain cheap in the future because the amount issued by the Treasury is much higher than the demand for securities. When the Treasury reintroduced debt in 2020, the first auction was for $20 billion, double what was recommended by the group of industry representatives – the Advisory Committee on Treasury Borrowing – which advises the Treasury on refinancing.

As pandemic-era fiscal spending has slowed, the Treasury has reduced the size of its 20-year auctions, alongside cuts to other maturities, but in the last quarter at a slower pace than recommended by the TBAC.

The 20-year is expected to remain out of fashion not only because of oversupply, but also because of rising volatility in the Treasury market as bonds are mowed down by recession fears and the Fed’s changing outlook. The 20-year generally experiences large swings in price when the markets turn volatile, as sluggish demand makes trading more difficult.

Chart showing bid-ask spreads between 10-year, 20-year and 30-year bonds

The low price, volatility and illiquidity have attracted a new generation of investors: hedge funds looking to exploit the inefficiencies of 20-year pricing.

“It takes a brave person or someone with deep pockets to hold on to [a position in the 20-year] for a long time and withstand a lot more volatility,” said John Madziyire, head of US Treasuries at Vanguard.

“That’s why you see hedge funds are the most likely to try to step in,” said Madziyire, who expects to remain underweight over 20 years due to the “conservative” approach. ” of the society.

The most active players over the past 20 years have been hedge funds and the group of banks that trade directly with the Treasury, called primary dealers, according to market participants.

“When you look at the risk you have with the leverage you need to apply to get real returns, it becomes a very, very difficult position for most people to hold,” said a portfolio manager at a large American hedge fund.

On Friday, the Treasury will send out a questionnaire to primary traders, seeking feedback on their quarterly redemption process, in which issue sizes are determined for the coming three months. Cabana said he would closely monitor any evidence that the Treasury was prepared to significantly reduce the size of auctions over 20 years.

“Treasury basically needs to cut until the [20-year] point stabilizes, but be open to the idea that there may not be any level of emission that is truly justifiable,” Cabana said.

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