(Bloomberg) -- The 20-year Treasury bond just drove home yet again why it has become a problematic maturity for traders of US government debt.
In the crucial market for borrowing and lending Treasuries — known as repo for its use of repurchase agreements — demand for the security far outpaced supply for several days last month. The imbalance created a shortage so pronounced that uncompleted trades — known as fails — exceeded all previous totals in the maturity, according to data released Thursday by the Federal Reserve Bank of New York.
Small numbers of fails are common due to human or system errors. But in a pattern that has repeated almost quarterly, these breakdowns in the 20-year dwarfed those in other maturities. In the week ended Sept. 25, fails to deliver the 20-year tallied $22.9 billion, the most on record in the data set, which has been published since 2022. That equated to 94% of the fails involving specific Treasury issues that week, according to the data, which cover trades involving primary dealers.
The fails subsided at the end of September when last month’s reopening of the 20-year settled, making the maturity more plentiful in the bond-lending market. But these recurring episodes are another sign that the Treasury’s move to reintroduce the 20-year in 2020 hasn’t panned out as hoped.
The bonds haven’t caught on with investors, and as a result the government has had to offer relatively higher yields to sell them, inflating taxpayer costs. To remedy that, the Treasury began shrinking auction sizes in 2021. But that has led to periodic, but severe, bouts of scarcity in the repo market, where traders go to borrow debt, offering an overnight loan of cash in return.
The upshot is a bond-market oddity: There is both too much of the maturity sloshing around, and simultaneously not enough. To repo professionals, the solution is either more 20-year bonds — or none at all.
“They should eliminate the 20-year, or increase it in size,” said Peter Nowicki, head of repo trading at Wedbush Securities Inc.
Representatives for the US Treasury had no comment on the shortages when contacted ahead of the latest data.
Smaller Auctions
Still, the finance department indirectly acknowledged the problem with 20-year bonds in July when it asked investors to identify themselves if they were large holders in December of one such security that became scarce. (Treasury issues this type of request once a year in an effort to guard against market manipulation.)
Given the expense to US taxpayers, halting issuance is the preference of former Treasury Secretary Steven Mnuchin. He oversaw the bond’s revival with the goal of offering another maturity to help lock in low borrowing costs for decades.
But others in the market expect the government to instead increase supply. Indeed, when the government’s cash needs began increasing again last year, it boosted 20-year auction sizes, albeit not as much as some other tenors. Treasury officials have said their next quarterly financing plan on Oct. 30 is unlikely to feature any increases.
“Treasury was very careful not to overload the sector over the last year, and now the auction sizes may have gotten a little too small,” said Gennadiy Goldberg, head of US interest-rate strategy at TD Securities USA. That means 20-year bonds are no longer as cheap as they used to be relative to other Treasuries, “but they sacrificed some repo availability.”
When the supply of a bond is limited in the repo market, there’s a greater risk of failed trades.
While traders routinely borrow Treasuries to cover short sales and hedge positions in other instruments, they also re-lend them for profit, forming a chain of borrowers. So, when one borrower doesn’t return a security on time — risking a fine from regulators — that can have a domino effect.
For the 20-year, those cracks tend to show up in the period between every third monthly auction and when those bonds settle about two weeks later, and become available to borrow. That’s what happened after Treasury sold $13 billion of 20-year bonds on Sept. 17.
The first indication of scarcity in the repo market is the interest rate that lenders of the bond pay on the overnight loan of cash they receive from the borrower. The greater the imbalance between the supply of an issue and demand to borrow it, the lower its so-called repo rate.
While normal repo rates are in the vicinity of the overnight interest rate set by the Fed, currently a range of 4.75% to 5%, the repo rate for the 20-year sank to below 2% in late September, according to data provided by Scott Skyrm, executive vice president at Curvature Securities LLC. It then went negative for several consecutive days — meaning that any trader who needed to borrow it had to accept a loss on the cash loan.
That’s sign of an acute misalignment between supply and demand and, as a result, failed trades spiked before the securities settled on Sept. 30. Repo rates on 20-year debt have since returned to near the Fed rate.
While all is now back to normal, Steven Zeng, an interest-rate strategist at Deutsche Bank AG, argues that the need to fix these spells of scarcity goes beyond any desire for smoother trading.
He’s pushed for bigger 20-year auctions as, to him, it’s about market confidence.
“Some fails are OK, but chronic fails erodes trust between counterparties,” he said.
--With assistance from Alexandra Harris.
©2024 Bloomberg L.P.