Treasury’s 20-year bond struggles to catch on with investors

Reintroduced last year for the first time since 1986, the 20-year bond was intended to help the government get the lowest possible long-term borrowing costs. For the past few weeks, however, investors have demanded extra payment to hold the 20-year bond instead of the 30-year, the government’s longest-maturity debt.

It isn’t supposed to work that way. Typically, investors insist on higher yields to hold bonds that will be paid back further in the future to compensate for the extra time in which inflation could accelerate or the Federal Reserve could raise interest rates. Yields on longer-term bonds sometimes drop below those of short-term bonds—in what is known on Wall Street as an inverted yield curve—because investors are worried about the economic outlook and think the Fed could cut rates.

But that isn’t what is happening now. The Treasury yield curve looks basically normal apart from the 20- to 30-year section. The main issue, analysts say, is that the 20-year bond has never completely caught on with investors, who are accustomed to making their bets on the economy by buying or selling other types of Treasurys.

Investors prefer 30-year bonds over 20-year bonds because they trade more frequently, said Thomas Simons, money-market economist at Jefferies LLC. That preference then reinforces the 20-year bond’s disadvantage, ensuring that it continues to trade less often than the 30-year bond.

“It’s an unfortunate sort of chicken-and-egg problem," he said.

Right now, demand for the 30-year bond relative to the 20-year bond is especially strong because investors have been crowding into one particular bet, analysts said.

Most investors think the central bank will raise short-term interest rates next year, thereby slowing inflation. Higher interest rates would hurt the appeal of short-term Treasurys. At the same time, slower inflation could reduce the need for interest-rate increases in the future, making long-term Treasurys more attractive by comparison.

As a result, investors have effectively been selling short-term Treasurys and buying longer-term bonds. But in doing so, they have concentrated on buying 30-year bonds more than the newer alternative with the somewhat shorter maturity.

As of Tuesday, the yield on the benchmark 20-year bond was 2.071%, compared with 2.022% for the 30-year bond.

The 20-year bond’s problems might not have been inevitable. The Treasury Department first announced it would bring back the bond in January of last year, a few days before the Centers for Disease Control and Prevention publicly confirmed the first Covid-19 case in the U.S. At the time, market participants had thought there would be strong demand for the new security from the likes of pensions and insurance companies looking for assets to match their liabilities.

As it turned out, though, the Treasury never had the chance to ease the 20-year bond into the market by issuing small amounts at first and then gradually scaling up, as it often does when introducing a new type of security.

That January, analysts at TD Securities guessed that the first 20-year bond auction in May would be $12 billion. Instead it was $20 billion and quickly grew as large as $27 billion by November as the Treasury was forced to fund massive coronavirus relief programs.

More recently, as those programs expire, the Treasury has been able to scale back borrowing. Not surprisingly, it has reduced the size of each 20-year bond auction by $4 billion—more than any other maturity.

Still, further cuts might be necessary.

“A year or two from now, we might see much smaller 20-year auctions that are more competitive," Mr. Simons said. The fact that the 20-year bond is yielding more than the 30-year bond is “the biggest red flag that that’s an adjustment that needs to happen."

This story has been published from a wire agency feed without modifications to the text