The 20-Year: A Month in Review

Below is an update on the cash traded yield curve via the Treasury Analytics tool from QuikStrike. Overall, the curve has been steepening during the month of June.  Front-end rates are indicating lower and stable interest rates, while longer dated rates have moved higher. Notice how the 20-year sector has maintained a kink throughout this time.

The kink in the curve at the 20-year point is explained partially by the additional supply from the May 20, 2020 auction, and partially by the fact that prior to the auction, the curve was simply a straight line between the 10-year and the 30-year. Looking at yield curves prior to 1986, when the 20-year was last a benchmark, that kink was normal. It was driven by both lack of liquidity and lack of demand in the sector.

The shape of this part of the curve is frequently viewed through a curve butterfly or ‘fly,’ a formula that subtracts two times the 20-year bond yield and adds the 10-year note and 30-year bond yields. It is a visual measure of the shape of the curve. Using end-of-month par treasury yield curve data from the US Department of the Treasury from 1976 to present, one can see the behavior of this part the curve for around the last 45 years.

Narrowing the focus down to the mid-1980s, the last time the 20-year was issued, the curve shape was quite positive and grew more so when Treasury discontinued the issuance of the 20-year year bond. The 10/20/30 implied Treasury butterfly went highly negative as the economy and stocks struggled into ‘Black Monday’ on October 19, 1987.

As liquidity builds in the sector, the kink should moderate as it was back in the 1980s, for the reasons Owain Johnson outlines in a CME Group Open Markets article he published on May 7, including more longer-dated issuance, relative value trading, spread trading, and managing the risk of longer-dated exposures.

With the new 20-year belonging to the Classic Bond’s deliverable basket, the long-end of the futures curve has seen increased activity. The proportion of US Treasury futures open interest held in Classic Bond (ZB) and Ultra Bond (UB) futures has grown to multi-year highs. The Bond-Ultra (BOB) yield curve spread on CME Globex, which offers an efficient proxy for the May 2040-Nov 2045 cash spread, has been highly active with YTD spread volume up 151% vs. 2019.

The newly issued 1.125 of May 15, 2040 is currently the most expensive to deliver and trade on spread to the 4.5s of February 15, 2036, the current CTD of the Classic Bond futures. While not a candidate to switch anytime soon, the Treasury Analytics tool is quite helpful to understand the nuances of the baskets, quickly see the underlying securities, and access top level analytics such as maturity, DV01, conversion factors and futures yield.

Here is a comprehensive view of the basket for Classic Bond futures using the Treasury Analytics tool from QuikStrike.

On June 17, the US Treasury will issue another $17 billion of 20-year bonds. It is an exciting time to watch the liquidly growing in both the cash and derivatives markets. Increases in trading in the long-end can help reinforce liquidity for both futures and cash. As the 20-year bond issuance outstanding grows, it is likely that more issuance will beget more trading that will beget more liquidity.