The Treasury Department is issuing a 20-year bond for the first time in 34 years to help pay for the ballooning $1 trillion dollar budget deficit.
The Treasury announced the new issue Thursday, and strategists said it could start trading as early as May. Treasury will announce more details Feb. 5, but strategists say the new bond should see good demand though it may trade at a discount initially as the market adjusts to it.
On Friday, news of the 20-year triggered a so-called "steepening" trade where Treasury yields on the long end of the curve rose, like 10-year and 30-year yields, and shorter duration yields, like the 2-year, fell. Yields move opposite price. Strategists say investors were betting the new 20-year will help drive rates higher at the long end of the Treasury curve. The 10-year yield Friday rose 2 basis points to 1.82%, while the 2-year yield was at 1.55%, off from a high of 1.58%.
"You've got more supply coming at the back end, and people think implicitly Treasury won't take all of the 20-year supply out of the 10-years and 30-years, so there's more long issuance coming and there will be less front end," said Michael Schumacher, director, rates at Wells Fargo. Strategists expect the Treasury to trim back some of its 10-year and 30-year bond issuance to make room for the 20-year and Schumacher said the Treasury could pare some Treasury bill issuance, which is its shortest term debt including 1-month and 3-month maturities.
Schumacher said the new 20-year could carry a yield similar to old 30-year bonds that mature in 2040, now yielding about 2.16%. He expects the Treasury would issue about $150 to $160 billion a month of the new security.
"For the 20-year, the plumbing is still all set up. This would fit nicely into the futures contracts," Schumacher said, noting the Treasury's net issuance is about $1 trillion a year. "If the Treasury had gone with the 50-year, it would have been out there by itself. It's guess work where that would have to price. This is a lot more clear."
Schumacher said he polled investors and there was much more interest in the 20-year than 50-year bonds. "We're fans of this," he said, adding he expects strong investor interest.
Other strategists do as well, though the issue may take some time to catch on.
"Out of the gate, we think it might trade a little cheaper than 10s and 30s, as the liquidity is built out and the investor community becomes used to the new auction schedule," said Ben Jeffery, fixed income strategist at BMO. "It makes a lot of sense to fulfill their funding needs. Given there's a natural demand point on the curve at the 20-year space, it matches better. It meshes with some of the traditional buyers of duration, like pension funds."
Strategists say the way Treasury made the announcement was a surprise, particularly since it could have announced it when it releases details on its refunding in February.
NatWest Markets strategists said they were surprised the Treasury was issuing the 20-year now, while it would have made more sense two years ago when the Treasury was looking forward to larger auctions.
"While deficits are still running high, the current auction calendar should already cover most of those funding needs, with bills (which will largely be absorbed by the Fed) picking up the difference. Contrast this to 2017, when coupon issuance was set to rise significantly and a 20-year could have easily been added to the calendar without needing to scale back at any other point," the NatWest strategists wrote in a note. "At that time, we had been strong advocates for a 20-year issue, and had even penciled one into our baseline forecasts. Now, with existing coupon auction sizes expected to remain flat, we had assumed the urgency to roll out a 20-year security would have waned."
The Treasury issued a total $2.7 trillion in Treasurys in calendar year 2019, including gross coupon bills, notes and bonds; floating rate notes and TIPS, and until this announcement those amounts were not expected to change, according to NatWest Markets.
Andrew Brenner of National Alliance says he would have preferred longer duration issuance, so the Treasury could take advantage of low interest rates to cover the growing debt.
"I would have loved to see a 40-year of 50-year but they [dealers] convinced the Treasury there wasn't demand for them," he said. "We really need to lock in low yields long term but 20-years was the compromise."
The budget deficit is expected to surpass $1 trillion for the first time since 2012 in this fiscal year, and it is expected to continue growing. For the year ended last Sept. 30, the deficit was $984 billion.