Cash Treasury Issuance: A Story of Supply and Command

Q2 auction schedule that held coupon issuance flat for the first time since the prior May. While borrowing in TIPS instruments still increased somewhat, the pause in coupons offered markets a breather from constant record auction sizes and a chance to evaluate what the pace will be going forward.

BrokerTec Treasury Benchmarks, which offer trading in the On-The-Run or most recently issued contracts at each tenor point, have seen both liquidity and price action build as market participants try to gauge the level of intervention and appetite for debt for the rest of 2021.

The Treasury has tested the capacity for the market to absorb unprecedented levels of debt, with success so far as the price of funding deficits has plunged. Individual auction sizes have increased, the Treasury reintroduced the 20-year bond in May 2020, and there has been a shift toward longer duration instruments.

Long-term tenors have always been smaller in size, and more expensive to the government, but rock-bottom yields have made the long end more appealing ‒ as noted by the Treasury in late 2019. As can be seen in the below graph, issuance was already on an uptrend, but mostly at the front end, reducing the relative share in the 10- to 30-year range (grey line).

As spending skyrocketed in 2020, and with it the need for increased debt issuance, the Treasury ultimately directed the excess into a relaunched 20-year, rather than create a 50-year bond or further inflate the 10-year or 30-year auction sizes. This tipped overall issuance notably back toward the long end, reversing the 2019 trend and rising to a share not seen in recent history.

Another way to view this shift is by looking to the year-over-year increases in individual auction sizes at each tenor and cumulative increases versus the relatively stable schedule prior to Q2 2020. Though individual 20-year CUSIPs are the smallest among the tenors, the total incremental issuance over the year easily outpaced each of the others at $273 billion.

Source: Treasury.gov

This in turn spurred a need for repositioning at the long end of the curve. Putting aside activity in the new 20-year bond, BrokerTec routinely saw combined 10-year and 30-year volumes making up as much as 55% to 60% of total benchmark Treasury volume, on a risk-adjusted basis.

The run-up in debt during 2020 finally showed signs of saturating market demand in Q3 and Q4. One measure of auction success is the bid-to-cover ratio, which compares the amount by which tendered bids exceed the issuance available for purchase. While this fluctuates from month to month, a number above two-and-a-half is generally considered healthy, as it means there is plenty of excess demand, with popular auctions reaching into the three- to four-times range.

From Q3 2020 to Q1 2021, tenors across the curve dropped below this two-and-a-half target with varying frequencies¹. The front end was relatively resilient with overall Bid:Covers averaging above two-and-a-half, but the longer-term notes and bonds showed signs of remaining below this rule of thumb on an ongoing basis. This makes sense as they were the recipients of the largest relative increases.

Below are examples for the 2-year and 10-year, which both show a general downward trend, but many more examples below two-and-a-half for the latter.

As an outsize buyer of new Treasury issuance, the Federal Reserve has established itself as a major driver of yields beyond the shortest term it sets via policy. However, its lack of aggressive action as back end yields rose, and direct guidance by the Federal Open Market Committee (FOMC) that it wishes to be neutral with respect to asset purchases and return to “normal market functioning”, indicate a desire to extract itself from active management of the yield curve.

The first step so far has been to move to a purchase schedule proportional to Treasury issuance. While tenor-neutral with respect to new debt, it has still meant a shift out on the curve due to the aforementioned trends in issuance. Ultimately, for some, “normal” markets would mean sharply higher yields especially at the long end, but the Fed has made known to primary dealers its preference for increased 20-year purchases, implying those yields could instead come down.

Given these tensions, it would not be surprising to see not only a continued rotation of the yield curve, but dislocations across tenors as competing opinions on what “normal” means and how quickly we can get there play out. 

U.S. Treasury products are offered by BrokerTec Americas LLC, a FINRA registered Broker Dealer and SIPC Member.