J.P.Morgan: 20-Year Supply Likely Requires Above-Avg End-User Demand

J.P.Morgan note that Wednesday will see “Treasury auction $14bn reopened 20-Year bonds, unchanged in size from the last reopening in June. Yields have declined more than 6bp since the June auction and are about 28bp off their highest levels in mid-June, but from a longer-term perspective, yields remain near their highest levels of the past decade.”

• “Moreover, there is meaningful relative value as well, as the 20-year sector has cheapened significantly along the curve over the last month and is trading near its cheapest levels since the GFC. Optically, this indicates that the sector is cheap, and should encourage above-average end-user demand for the auction process. The recent cheapening has been excessive, even after accounting for the rise in delivered volatility and decline in risk appetite.”
• “However, as we argued in recent weeks, this cheapening is indicative of the plight of the Treasury market now: amid uncertainty over the Fed’s reaction function and depressed liquidity conditions, the least liquid sectors have lost sponsorship and borne the brunt of the underperformance recently. This indicates that current auction sizes in this sector remain somewhat too large, particularly relative to the guidance given to Treasury prior to the 20-Year bond’s reintroduction in 2020.”
• “Going forward, though valuations are cheap, we do not envision any mean reversion until volatility declines meaningfully and liquidity improves. With the July FOMC meeting still a week away and liquidity conditions likely to worsen in the coming weeks, the 20-Year sector is likely to remain very cheap on the curve. Accordingly, it will take above-average end-user demand in order to absorb tomorrow’s auction without incident.”