At a Glance
- Given government outlays related to the COVID-19 stimulus, growth in the classic bond deliverable basket is expected to increase
- The new bond will provide an additional trading point on an interest rates curve that has seen derivative volumes surge in recent years
The U.S. Department of the Treasury will issue significantly more debt than the market had expected in the wake of the COVID-19 crisis, including some $54 billion over the next three months in the form of 20-year bonds, according to an official announcement on May 6.
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.
20-Year Bond, We’ve Been Expecting You
Beyond the next three months, if the 20-year bond becomes an established part of the Treasury’s regular issuance cycle, then it should become the seventh actively traded U.S. Treasury tenor, joining the two, three, five, seven, 10 and 30-year bonds, all of which trade on CME Group’s BrokerTec platform.
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.
The new bonds are expected to increase liquidity in CME Group’s Treasury Bond futures contract. The new issuance will fall squarely in the middle of the deliverable criteria of bonds with between 15 and 25 years to maturity.
Already the second largest deliverable basket after the Classic 10-year, the bonds could see a significant increase under even conservative estimates. And given government outlays related to the COVID-19 stimulus, this growth could be even greater.
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. The curve has aggressively steepened over the past few weeks alongside anticipation of growing coupon issuance.
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 many note and bond futures in this part of the curve, 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 new 20-year bond will mature on May 15, 2040. It is currently trading as the When Issued (WI), spread against the U.S. Treasury Bond 3% of November 15, 2045 on CME BrokerTec. The 3% of November 2045 is currently the Cheapest-To-Deliver for the Ultra-Bond Futures June and September 2020 contract months. Importantly, the new WI May 15, 2040 will belong to the delivery basket of the Classic Treasury Bond Futures contract. Therefore, the cash WI May 2040 versus the 3% of Nov. 2045 spread is similar to the Bond-Ultra, commonly called BOB, yield curve spread on CME Globex. This relationship provides a rich set of risk management, spread and box trading strategies.
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 over 1 million lots of open interest in early May 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.