As investors assail the US Treasury market, pushing yields to the highest levels in years, the still-new 20-year sector is a sitting duck for nimble traders.
The sector, which was revived in May 2020 after a hiatus of more than 30 years as the federal borrowing need ballooned, cheapened significantly last week against its closest peers. And that’s been creating potential opportunities — and risks — for traders trying to take advantage of dislocations between different parts of the rates market that are in part fueled by illiquidity.
The so-called value-at-risk shock that accompanied last week’s Treasury-market selloff “hit the 20y bond, driven by spread and curve relative value trades,” Citigroup strategist Jason Williams wrote in a March 11 note. A VaR shock, as it is commonly known, refers to a loss explosion that forces positions to be liquidated.
The 20-year sector “tends to cheapen up when liquidity is low” because of “the lack of real money demand and participation,” according to Williams. That’s despite the fact that the US Treasury Department has, since November, reduced auction sizes for the tenor even more than some of its other offerings.
That kind of cheapening was evident last week in a gauge that compares the 20-year yield to the averaged yields of 10-year notes and 30-year bonds. This so-called butterfly spread reached the highest level since the March 2020 liquidity crisis, indicating that buyers have notably less appetite for the 20-year bond than the other securities.
Key metrics for the performance of cash Treasuries relative to derivatives like futures and swaps were also jolted. The so-called invoice spread for US Treasury Bond futures — which closely track the 20-year sector — widened as futures outperformed, and swap spreads tightened as swaps outperformed cash bonds.
Moves like that are catnip for the basis trade, in which a position in futures is paired with a position in the underlying note or bond.
Barclays Plc strategists also have observed a tendency for the 20-year sector to take the brunt of the beatings the Treasury market has been subjected to.
It “has tended to cheapen sharply when liquidity conditions worsen reflecting stop outs from the leveraged community (who are structurally long to capture the liquidity risk premium),” Anshul Pradhan wrote on March 11.