How 20-Year Bonds Will Fit in Interest Rate Markets

At a Glance

  • The new bond will provide an additional trading point on an interest rates curve that has already seen derivative volumes surge in recent years
  •  The launch is likely to enhance liquidity in both the cash and futures markets, creating new trading opportunities

News that the U.S. Department of the Treasury is planning to issue 20-year bonds in the next few months has generated substantial attention from the interest rate market.

The Treasury believes that there will be strong demand from investors for the 20-year bonds, which will allow the Treasury to finance its longer-term obligations at today’s very low interest rates.

Once introduced, the Treasury has stated that it will make the 20-year bond part of its benchmark suite by issuing the bonds regularly, predictably and in substantial size.

New Bond on The Block

If the Treasury makes the 20-year bond part of its regular issuance cycle, then the new bond may become the seventh most actively traded U.S. Treasury tenor, joining the two, three, five, seven, 10 and 30-year bonds, which are actively traded on CME Group’s BrokerTec platform.

The 20-year bond will also be eligible for delivery into CME Group’s Treasury Bond futures contract, as the new issuance will fall squarely in the middle of the deliverable criteria of bonds with between 15 and 25 years to maturity.

As with all new financial instruments, liquidity is expected to build gradually in 20-year bond trading, although market participants expect secondary trading to take off relatively quickly amid strong interest from asset managers and other longer-term investors.

Overall trade volumes in the new instrument will be highly dependent on the size and scale of the Treasury’s issuance plans, which will be announced in its quarterly refunding statement on February 5, 2020.

Trading Prospects

The new 20-year bond should find a ready audience, both with investors and with traders for whom it will provide a significant additional trading point on an interest rates curve that has already seen derivative volumes surge in recent years.

Much of the growth in activity levels has been driven by asset managers, such as pension funds, who are the primary end-users of interest rate products.  Asset managers have been attracted by the off-balance sheet efficiencies of futures as they look to manage the risks related to their long-term commitments.

Longer for Longer

The new 20-year bond issuance fits with the general trend in the interest rate market towards longer-dated exposures.  It also provides new opportunities of spread trading for hedge funds and other proprietary traders. They will be able to express their views on the relative value of the 20-year bond against other related instruments, including Treasury Bond futures, which typically tracks a cheapest-to-deliver bond value at around the 15-year mark.

There is already significant market activity beyond the duration of the proposed 20-year bond.  The Treasury continues to issue 30-year bonds in significant quantities and the CME’s Ultra U.S. Treasury Bond futures are based on a deliverable basket of Treasury bonds with at least 25 years remaining to maturity.

The growing interest in managing the risk of longer-dated exposures can be seen in the performance of the Ultra 10 futures, which has become CME’s fastest growing interest rates product launch in history.  The Ultra 10 had almost 1 million lots of open interest in early 2020.

The proposed 20-year bond would add another issuance point on the cash bond curve between the existing 10-year Treasury bonds and the 30-year bonds, replicating a term structure that has proved effective on the futures side for some time.  By doing so, 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.

is Global Head of Research at CME Group. He is based in London.

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