20-year US Treasury auction
Tomorrow the US Treasury will sell $16 billion in new 20-year notes (US912810TU25), the infamous tenor that was re-introduced in 2020 after being discontinued in 1986.
Investors buying into the first 20-year notes issued in June 2020 (US912810SR05) have seen their mark-to-market value falling slightly over 101 to 60 as the Federal Reserve hiked interest rates to fight inflation. The sale of these notes has sometimes sparked volatility in the bond market. During last October’s 20-year auction, poor demand accelerated the US Treasuries selloff. In the three days following the auction, the 20-year yield spiked by 30bps, and 10-year US Treasuries rose by 20bps. The risk for the same to happen this time is high, as tomorrow's auction sale has increased by $1 billion, and many traders are either on vacation or reluctant to add duration to their portfolio before the Jackson Hole meeting.
However, there is a chance for the opposite to happen. Indeed, 20-year notes offer 20 basis points over 30-year US Treasuries, paying 4.6% in yield. The premium 20-year notes pay over a longer duration represent an illiquidity premium. Indeed, there are much fewer 20-year notes in circulation than 30-year notes. Yet, such a premium might be enticing for those investors anticipating the Fed to end its hiking cycle and looking for protection in case of a recession.
The new 20-year notes (US912810TU25) will pay a coupon of 4.5%. If investors secure it at a yield of 4.6% and hold them until the end of 2024, they will lose -0.5% if 20-year yields go to 5.2% and gain 14.23% if yields fall to 4%.