J.P.Morgan On The Headwinds For 20s

J.P.Morgan note that “the 20-Year sector has suffered periodically over the last year and a half, and particularly over the last week, cheapening 10bp relative to a 10s/30s butterfly over the period. As a result the sector now trades cheaper on this butterfly than at any point since 2009. At its root, we think improper auction sizing is initially responsible for the cheapening of the 20-Year sector over time. Treasury has attempted to address this issue, cutting 20-Year auction sizes more aggressively than surrounding tenors since last fall, but CUSIPS remain larger compared with 30-Year bond auction sizes than both primary dealers and the TBAC recommended before the tenor was reintroduced in 2020. Moreover, while smaller issue sizes will likely benefit 20-Year liquidity over time, it will not help the large-sized, illiquid off-the-run complex, and original-issue 20-Year bonds in the 2040-2041 sector all appear 3-4bp cheap to our fitted curve. Though we think liquidity conditions should improve over the balance of the year as the hiking cycle ages, it is unlikely they improve appreciably over the near term as the pendulum swings back and forth between persistently elevated inflation and increased recession risks. Thus, we think the 20-Year sector will remain dislocated until volatility declines from these excessively high levels: though we look for the Treasury to keep coupon auction sizes unchanged at the August refunding announcement, the ongoing dislocations in the sector indicate a risk Treasury cuts 20-Year auction sizes by another $1-2bn next month. Volatility aside, the behavior of the 20-Year sector underscores structural issues and bouts of illiquidity will be commonplace until a more concerted effort is made to strengthen market resiliency and increase intermediation to keep up with the ongoing growth of the Treasury market.”