(Bloomberg) — The 20-year Treasury note is yet another reminder of why the 20-year Treasury has become a problematic maturity for U.S. Treasuries traders.
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In the key market for borrowing and lending of government bonds, known as repos due to the use of repurchase contracts, demand for the securities far exceeded supply for several days last month. The imbalance has made the shortage so pronounced that uncompleted trades, known as fails, exceed the total of all previous maturities, according to data released Thursday by the New York Fed.
It is common for a small number of failures to occur due to human or system error. But in a pattern that repeats almost every quarter, this breakdown for the 20-year seemed small compared to other maturities. The week ending September 25th missed the 20-year tally of $22.9 billion, the largest ever for any data set published since 2022. This represents 94% of the failures associated with a particular Treasury stock that week. The data covers transactions involving primary dealers, according to the data.
Bankruptcies subsided by the end of September, when last month’s 20-year bond reopening was finalized, and maturities became more plentiful in the bond lending market. However, these repeated incidents are another sign that the Treasury’s move to reintroduce the 20-year system in 2020 did not work out as expected.
The bonds have not been well-received by investors, and as a result, the government has to offer relatively high yields to sell them, increasing the burden on taxpayers. To remedy that, the Ministry of Finance began reducing the size of auctions in 2021. But that resulted in regular and severe shortages in the repo market, where traders go to borrow money and instead end up lending out cash overnight.
The result is a strange situation in the bond market. Maturities are both too variable and not enough. For repo experts, the solution is to buy more 20-year bonds or not buy them at all.
“We should get rid of the 20-year or expand it,” said Peter Nowicki, head of repo trading at Wedbush Securities.
Representatives from the U.S. Treasury Department did not comment on the shortfall when contacted ahead of the release of the latest data.
small auction
Still, the Treasury Department indirectly acknowledged the problem with 20-year bonds in July, asking investors to reveal whether they were large holders of the now-scarce 20-year bonds in December. (The Treasury Department issues this type of request once a year to prevent market manipulation.)
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It is former Treasury Secretary Steven Mnuchin’s intention to suspend publication, considering the burden on U.S. taxpayers. He oversaw a resurgence of bonds with the aim of setting alternative maturities to keep borrowing costs low for decades.
But other players in the market expect the government to increase supply instead. Indeed, when the government’s need for cash began to rise again last year, the size of bids for 20-year notes increased, although not as much as in some other periods. Treasury officials said the increase is unlikely to be included in the next quarterly funding plan, to be released on Oct. 30.
“Treasury has been very careful over the last year to not overload the sector, but now the bid size has become a little too small,” said Gennady Goldberg, head of U.S. rates strategy at TD Securities USA. There is a possibility.” This means 20-year bonds are no longer as cheap as they once were relative to other government bonds, “but the availability of repos has been sacrificed to some extent,” he said.
If the supply of bonds is limited in the repo market, the risk of a trade failing increases.
Traders routinely borrow U.S. Treasuries to hedge short sales and positions in other financial instruments, but they also re-lend the bonds for a profit, forming chains of borrowers. Therefore, if a borrower does not return securities on time, he risks fines from regulators, which can create a domino effect.
For 20-year bonds, these cracks tend to appear during the three-monthly auctions and the period until the bonds settle and become available for borrowing, about two weeks later. This happened after the Treasury Department sold $13 billion of 20-year bonds on September 17th.
The first indication of scarcity in the repo market is the interest rate bond lenders pay on overnight cash loans they receive from borrowers. The greater the imbalance between the supply of issuance and the demand to borrow it, the lower the so-called repo rate.
While regular repo rates are around the overnight rate set by the Fed, which currently ranges from 4.75% to 5%, the 2020 repo rate fell below 2% in late September, according to data provided by financial institutions. said Scott Skym, executive vice president of Curvature Securities LLC. After that, it became negative for several days in a row. This meant that traders who needed to borrow had to accept losses on cash loans.
This is a sign of a severe imbalance between supply and demand, resulting in a spike in failed trades by September 30, when the securities are due for settlement. The 20-year repo rate has since returned to near the Fed rate.
Although everything is now back to normal, Deutsche Bank interest rate strategist Steven Zen argues that the need to solve this scarcity curse goes beyond the desire to facilitate trading. .
For him, it’s about market confidence, which is why he’s pushing for a larger 20-year bid.
“Some failures are OK, but chronic failures erode trust between trading partners,” he said.
–With assistance from Alexandra Harris.
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