Managing Behemoth Treasury Issuance

Interest Rates trading is more interesting now than ever.

  • US Treasury issuance has been, currently is, and will continue to be enormous into the foreseeable future, in order to support fiscal stimulus from COVID-19 packages, infrastructure, and economic activity. The curve has been steepening in response.
  • Record bill and coupon issuance will continue, and duration hedging will increase further. A tsunami of cash will struggle to find a home. The Treasury will issue more coupons to extend the duration of the debt in the second half of the year.
  • The Fed continues to purchase assets, but to a much lesser extent. Risk managing duration will be critical.
  • For these elevated risk management and hedging needs, the TreasuryWatch tool provides guidance to understand these trends and activity.
  • The total cost of trading is more important and Treasury futures provide a deep and liquid pool for trading activity with transparency, ease of use, and balance sheet efficiencies.
  • Cash market trading is growing in both the long-end (20-year) and in repo. BrokerTec complements these offerings as a full broker dealer for US, European, and Japanese trading and repos.

Issuance

Macro is back and bigger than ever. The US interest rates market has never been more influenced by the crosscurrents of major policy stimulus and market activity. The largest historical budget deficits and debt issuance combined with macroeconomic policy has created large uncertainty with respect to inflation, unemployment, and GDP ‒ making the rates trading ecosystem the most interesting it has been in decades.

Debt issuance is a critical component to understanding the Treasury market. Table 1 examines the prior five years’ worth of net issuance, and Figure 1 further highlights issuance composition. To raise the necessary funding for the government’s much larger expenditures, net bill issuance was 2.5 times larger than the prior four years.

Table 1: US Treasury Net Issuance Prior Five Years

Year

Bills

Notes

Bonds

Total

2016

304

248

145

697

2017

138

234

162

534

2018

384

520

201

1,105

2019

77

743

220

1,040

2020

2,547

1,258

476

4,282

Source: SIFMA

Figure 1: US Treasury Net Issuance Prior Five Years by Issuance Type

Source: SIFMA

Table 2: US Fiscal Relief Acts 2020 and 2021 to Date

Name of Act

Short Name

Amount (Trillions USD)

Date

Coronavirus Aid, Relief, and Economic Security Act

CARES Act I

 $2.2

March 27, 2020

Consolidated Appropriations Act, 2021

CARES Act II

 $0.9

December 27, 2020

American Rescue Plan Act of 2021

American Rescue Plan

 $1.9

March 11, 2021

Total

 

 $ 5.0

 

Source: IMF

Large bill issuance is expected to continue. Importantly, so will coupon issuance. The Treasury will try to extend the duration of debt even as more bills are issued. The CME TreasuryWatch tool coupon forecasts that monthly coupon issuance should surpass $350 billion per month later this year.

The TreasuryWatch Tool

Use the CME Group TreasuryWatch Tool to help manage these elevated risks. It provides a quick and comprehensive overview of important market information in a clean, concise view. Elements of the tool are built in a robust manner that aggregates important data to provide an overview, while also granting the user the ability to perform detailed drill-down analysis. Users can download information in an easily accessible PDF file for storage and retrieval.

Figure 2 shows the interactive and dynamic components layout. It also highlights the expanded CME Group coupon issuance history and the forecast for the upcoming quarter, showing potential aggressive coupon issuance.

Figure 2: TreasuryWatch Tool

Fed purchases – Purchases no longer offset the tsunami of cash and duration

The Federal Reserve Bank of New York (FRBNY) Open Market Desk (Desk) purchases assets and holds them in its System Open Market Account (SOMA). The holdings of notes and bonds increased by $2 trillion in 2020. Importantly, 65% of these purchases occurred during a tumultuous seven-week period from March 11, 2020 until April 29, 2020. During that time, the Desk purchased $1.3 trillion of Treasuries. The TreasuryWatch Tool in Figure 2 lower left in gray, charts the explosion of US Treasuries purchases into the SOMA.

After that frenetic rate of purchases, the Desk has been active, to a lesser extent, resulting in more durations hitting the market. The Desk does continue to purchase $80 billion of Treasury securities per month. On December 16, 2020, the FRB announced:

Effective December 17, 2020, the Federal Open Market Committee (FOMC) directed the Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York to continue to increase the System Open Market Account (SOMA) holdings of Treasury securities by $80 billion per month … will continue at their current pace and composition, and the existing purchase schedules for these securities, released on December 11, 2020, will remain in effect.

More issuance and fewer purchases continue to steepen the curve

While $80 billion in Treasury security purchases per month is an impressive amount, $350 billion of forecasted Treasury coupon issuance overwhelms those purchases by over four times.

The US Treasury Quarterly Refunding Announcement on February 3, 2021 held issuance levels consistent to the prior quarter’s issuance levels. This seemed reasonable given the uncertainty of additional potential fiscal stimulus and the large amount of cash holding that the Treasury has on hand. However, CME Group has forecasted that over the next quarter, the Treasury will increase its coupon issuance roughly along trend from prior quarters ‒ as it seeks to rely less on massive coupon issuance as well as extend the duration of the debt.

As a result, coupon issuance is expected to be in excess of four times the amount of monthly purchases by the Desk into the SOMA account. Hedging and risk management will be extremely critical in 2021.

Figure 3: Treasury Futures Yield Curve Continues to Steepen

Source: CME Group and QuikStrike

The market has been watching this space closely. Notice that much of the pivot is making the 10-year point critical in the yield curve. The Ultra 10-Year future has been growing in demands as market participants see the value in this liquid future. Read more about the specifics of the Ultra 10-Year futures and how it has become a $100 Billion Market.

Figure 4: Ultra 10-Year Setting Records

Source: CME Group, CFTC Commitments of Traders Report

Multiple value propositions of Treasury futures

Treasury futures are an excellent product for risk management and are extremely efficient to trade. The Central Limit Order Book (CLOB) is an electronic, all-to-all, anonymous trading venue for transparency and ease of use. The US Treasury futures market is among the deepest liquidity pools of any financial product in the world and has the largest network of global asset managers, hedge funds, banks, PTFs, mortgage clients, insurance and pension funds, and others. Bid/ask spreads are at minimum tick sizes and book size continues to grow. As the study by the CFTC, The Liquidity Hierarchy in the U.S. Treasury Market, concluded:

Futures contracts play a special role in liquidity-challenged environments. The relative amount of risk traded through futures contracts is higher on days with large price movements and is larger at times outside of U.S. trading hours.

In addition, there are many services to improve the robustness and efficiency of trading Treasury futures include: bilateral trading for block trades and cash/futures basis (via EFP), Inter-Commodity Spreads for curve trading, and importantly, margin offsets between Treasury futures and options and with OTC via portfolio margining.

Weekly Treasury options for event risk

Weekly options on Treasury futures provide one of the most effective and elegant methods to manage exposures to material economic, political, and other event risks. Short-dated interest rate volatility has experienced significant swings over recent weeks, as markets digested a range of economic, political, and COVID-19 updates. Going forward, as market participants assess the path of inflation and policy initiatives, hedging using economic data via Weekly options on Treasury futures will continue to be important. Learn more about the products here. Figure 5 highlights the large amount of open interest and large positions in puts.

Figure 5: 10-Year Weekly Options Open Interest as of April 27, 2021

Source: CME Group, QuikStrike

Volatility on 10-Year futures is at an elevated state compared to prior months as shown by the CME Group volatility indexes (CVOL) on 10-Year Note futures in Figure 6. Derived from the deep liquidity in Treasury futures markets, CVOL is calculated using variance and is now offered across a range of asset classes. See more at the CME Group Volatility Index (CVOL).

Figure 6: 10-Year Treasury CVOL Index (TYVY)

Source: CME Group, QuikStrike

Across the curve and the trading spectrum, CME Group Treasury futures, analytics, and services provide great value.

Value propositions of Treasuries on BrokerTec

BrokerTec’s offerings can often be utilized as an effective complement to Treasury futures. BrokerTec offers a suite of US and EU products, including US Treasury Actives Benchmark and Repo securities1. BrokerTec offers an extensive, anonymous, and fully electronic Central Limit Order Book for US Treasury Actives and Repo securities, providing liquidity to a broad base of institutional participants. One can now access BrokerTec with efficient APIs via CME’s Globex technology.

BrokerTec makes it easier than ever to trade Treasuries and Repo

Curve trading was recently launched, offering an efficient way to trade the yield curve. See Introducing the BrokerTec RV Curve to understand more.

Figure 7: BrokerTec RV Curve Offerings and Ratios

Outright Leg

2-year

3-year

5-year

7-year

10-year

20-year

30-year

2-year

 

3:2

5:2

3:1

5:1

10:1

10:1

3-year

3:2

 

3:2

2:1

3:1

5:1

8:1

5-year

5:2

3:2

 

3:2

2:1

3:1

4:1

7-year

3:1

2:1

3:2

 

3:2

2:1

3:1

10-year

5:1

3:1

2:1

3:2

 

2:1

2:1

20-year

10:1

5:1

3:1

2:1

2:1

 

3:2

30-year

10:1

8:1

4:1

3:1

2:1

3:2

 

Source: CME Group

While long-term rates began to rise in early 2021, the short end of the curve remains at historic lows. Following the success of minimum price increment reductions in the BrokerTec 2-Year Treasury Note and CBOT 2-Year Treasury Note futures, a tick cut in the 3-Year Treasury Note in May will allow more precise hedging and price discovery. See Smaller Ticks, Lower Costs: BrokerTec Reduces 3-Year MPI how reductions in tick sizes increase the value proposition across the curve. All this comes off the back of the relaunch of 3-Year Note futures that clients rely upon for outright and relative value trading.

Figure 8: CME Futures Growth Post Minimum Price Increment Reduction

Source: CME Group

This is all happening with the backdrop of more cash coming into the market from the Treasury. Understand the mechanics of why so much cash is hitting the market with the Trillion Dollar Helicopter. BrokerTec’s repo platform provides services to manage financing for Treasuries across GC and specializes in overnight and term repo.

Figure 9: CME Group Helicopter Indicator – More Cash on the Way

Source: CME Group and FRB H.4.1 Factors Affecting Reserve Balances

The place for rates markets

Across the most interesting rates complex in generations, CME Group provides the highest value and service across Treasury futures, analytics such as the TreasuryWatch Tool, options on Treasury futures for event risk, as well as cash trading of US Treasury, European, and Japanese trading and repos. The future has never been more interesting and full of possibility.


References

  1. US Treasury products are offered by BrokerTec Americas LLC, a FINRA registered Broker Dealer and SIPC Member.  In the UK, BrokerTec Europe Limited is authorised and regulated by the Financial Conduct Authority. CME Amsterdam B.V. is regulated in the Netherlands by the Dutch Authority for the Financial Markets (AFM) (www.AFM.nl).

About CME Group

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