Three decades after discontinuing issuance of the 20-year Treasury, the U.S. restarted auctioning the security in May 2020. Leading up to that event, various studies and consultations with market participants suggested that the 20-year maturity point would find steady demand: In theory, pension plans, insurers and corporate issuers would all find something to like about a liquid option in the middle of a maturity sector of high-coupon, heavily seasoned bonds, the Treasury would get to diversify its program, investors would achieve a more natural fit and everyone would win.
Unfortunately, the reality has been far from smooth. While the 20-year issuance program remains in its infancy—only four issuances from the new program are currently outstanding—the lauded benefits and projected sponsorship have not delivered the liquid, on-the-run series profile that the market expected. Instead, we have seen the opposite effect.
Conventional wisdom would suggest that on-the-run securities should trade with a liquidity premium, especially when market conditions are strained, and pairing buyers with sellers at reasonable prices becomes more difficult; however, in the most recent episode of such strained conditions, the new 20-year series did not exhibit these preferable attributes. Not only did it heavily underperform on spread versus 10- and 30-years, the on-the-run 20-year actually cheapened against its matched-maturity, heavily seasoned high-coupon counterpart, a bond that was issued in 2011. That an auction point would display this uncharacteristic, off-the-run price performance is in our view a surprising, and concerning, development in a program that provided high hopes to both the Treasury and investor communities.
Despite this dramatic cheapening, the 20-year point recouped over half of this loss in the subsequent trading session. Moreover, bright spots for demand still exist: The Fed has purchased them in buybacks, and the trading community is considering transitioning corporates in the sector to trade off the 20-year on-the-run. In our view, heightened volatility pushed these bonds too far away from fair value and, while perhaps hurting the credibility of the 20-year, this turbulence will likely create similar relative value opportunities now and in the future.