New 20-Year U.S. Treasury Issuance: Implications for Investors

Andrew Higley

Andrew Higley, CFA

Head of Derivatives and Liquid Trading

Sam Wilson

Sam Wilson, CFA

Vice President, Senior Credit Analyst

The 20-year U.S. Treasury issuance will be a new addition to the risk-free curve – here is what investors need to know.

Executive Summary

  • The U.S. Treasury announced it will issue 20-year bonds later this year; a widely expected new addition to the risk-free yield curve, but the timing was a surprise
  • The new maturity will bridge the 10- to 30-year maturity gap, improving investors’ ability to manage duration risk
  • The 20-year U.S. Treasury issuance will provide a more closely matching benchmark for 15- to 25-year corporate bonds, and over time should experience relative spread outperformance versus 10s and 30s and an increasing share of the investment grade (IG) new issue market due to what we believe will be growing investor demand
  • We see three key drivers that will determine the magnitude of these outcomes: The 20-Year curve will look too steep versus the 10-year and too flat versus the 30-year; the new maturity should drive greater confidence and focus; strong demand from insurance and pension plans

Background

The U.S. Treasury announced in mid-January that it would begin issuing new bonds on the 20-year part of the yield curve. While the issuance of 20-year Treasuries was largely expected, the timing came as a surprise to many investors. The rationale behind the announcement was to take advantage of historically low long-dated interest rates in order to fund a deficit that is approaching $1 trillion annually. Issuance is expected to begin around mid-year and has several implications for both the rates and corporate bond markets.

A Missing Piece of the Rates Market Puzzle

The key implication of the 20-year Treasury issuance for the U.S. rates market is that it improves investors’ ability to effectively manage interest rate risk in portfolios by providing a new point of price discovery on the yield curve. Historically, market participants could observe the highly liquid trading of on-the-run 10- and 30-year bonds but would have to use mathematical techniques to determine the fair value of 20-year maturities as lessliquid, off-the-run 30-year issues aged their way through this segment of the yield curve.

This will now be easier; the 20-year bonds will provide market participants greater transparency by allowing a more complete risk-free curve upon which to discount various fixed income cash flows. Additionally, this will allow for more precise key rate duration hedging techniques. Given the idiosyncratic illiquidity of the off-the-run bonds in the 20-year segment of the curve, derivatives were often the best choice for hedging 20-year key rate duration. Now, investors will have an additional, liquid cash instrument from which to choose.

Impact on Credit Markets

The 20-year U.S. Treasury issuance will provide a more closely matching benchmark for 15- to 25-year corporate bonds, which have historically relied on the on-the-run 30-year Treasury yield. Over the next two or three years, we believe this part of the credit curve should experience relative spread outperformance versus 10s and 30s, garnering an increasing share of the investment grade (IG) new issue market and experience strong investor demand. Ultimately, the magnitude of these outcomes will depend on where the 20-year U.S. Treasury ends up trading. We see three major drivers of these outcomes.

Driver 1: The 20-Year credit curve will look too steep versus the 10-year credit curve and too flat versus the 30-year credit curve relative to the current convention. Since there is no benchmark for the 20-year U.S. Treasury, market convention calls for 20-year corporate bonds to be quoted based on the 30-year U.S. Treasury yield. Typically, a 20-year Treasury bond traded more than 10 basis points lower than an on-the-run 30-year Treasury, leading to the supposition that the option-adjusted spread of a typical 20-year corporate would look more than 10 basis points wider if quoted off the 20-year Treasury. As a result, the option-adjusted spread of a new 20-year corporate bond quoted off a new 20-year U.S. Treasury bond might look too steep relative to 10-year corporates and too flat relative to 30-year corporates (Figure 1), which potentially could drive relative outperformance of the 20-year corporate issue.

Figure 1. 20-Year Corporates Look Steep versus 10-Year, Flat versus 30-Year
Figure 1. 20-Year Corporates Look Steep versus 10-Year, Flat versus 30-Year

Source: Credit Suisse, as of January 2020.

Driver 2: The new benchmark 20-year U.S. Treasury should drive greater investor and issuer confidence and focus. Off-the-run 20-year Treasury yields are likely to be distorted by high dollar prices and relatively less liquidity, dampening confidence when pricing corporate bonds. Similarly, most 20-year corporate bonds are 30-year issues that have rolled down the curve and therefore have a higher dollar price (Figure 2) and lower liquidity profile. Having a liquid, par benchmark should give investors and issuers more clarity on the value offered at the 15- to 25-year part of the curve.

Figure 2. Most 20-Year Corporates Carry High Dollar Prices
Figure 2. Most 20-Year Corporates Carry High Dollar Prices

Source: Credit Suisse, as of January 2020.

As the 15- to 25-year part of the credit curve receives greater focus from both investors and issuers, its liquidity profile should improve. Additionally, the 15- to 25-year space has grown significantly post-crisis and makes up about 13% of the IG market (Figure 3). We expect this trend of increased issuance to continue, eliminating some theoretical illiquidity premium and allowing greater price discovery. This increased issuance will come at the expense of 10-year and 30-year issuance, which could further extend the duration of the corporate bond market.

Figure 3. Issuance of 20-Year Corporates Has Grown Significantly Post-Crisis
Figure 3. Issuance of 20-Year Corporates Has Grown Significantly Post-Crisis

Source: Credit Suisse, as of January 2020.

Driver 3: There should be strong demand from insurance and pension plans, including those located in Asia and Europe. Twenty-year bonds are a natural fit against the long-dated liabilities held by most liability-driven investment (LDI) managers. As more U.S. pensions are frozen the duration of their liabilities should decrease over time, likely leading to increased demand for 20-year assets over the 30-year assets such plans typically have purchased. Meanwhile, 20-year corporates likely will be well received by investors in Europe and Japan, who have largely shied away from the 30-year segment of the credit curve and have a more natural demand for the 20-year segment.

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