The U.S. Treasury recently announced that it will begin issuance of benchmark 20-year bonds through predictable auctions and in sizes sufficient to maintain benchmark liquidity. As a result, high-grade corporate bonds in the 20-year tenor have received renewed attention. Historically, 20-year corporate bonds have been more challenging to value than the rest of the spread curve due to the absence of a true 20-year Treasury benchmark. The current trading convention is to quote 20-year bonds off of the 30-year Treasury benchmark. The majority of bonds in the 20-year range are old 30-year bonds that have rolled down the curve and have a wide range of coupons, dollar prices and liquidity.
As a valuation measure, the G-spread of 20-year corporate bonds in the index is the spread between the bond yield and the interpolated, active Treasury 10s-30s curve. The actual on/off-the-run Treasury curve in this maturity range trades cheaper than this interpolated curve. Using the active Treasury 10s-30s interpolated curve, the G-spread for 20-year paper is about five basis points (bps) greater than the spread when using actual Treasuries. This week’s chart demonstrates the 20yr/30yr G-spread curve inversion for investment-grade (IG) corporate bonds in the Bloomberg Barclays Index.
Aside from using the interpolated Treasury curve, a significant part of this 20yr/30yr spread inversion in the index can be explained by the many bonds with very high dollar prices, since they were issued years ago as 30-year bonds when rates were much higher. The Bloomberg Barclays Long U.S. Corporate Index’s average dollar price is at an all-time high, approaching $125. Some bonds are as high as $170. In recent years, more corporations have issued 20-year bonds in order to spread out maturity walls and appease investor needs. These par bond issuances trade better than indicated by the broader index. With more corporate issuance in this tenor and high-dollar bonds rolling down the curve, I expect the 20yr/30yr spread curve to steepen.
A key question going forward is where the 20-year Treasury will trade. I anticipate new issuance to trade slightly wider than the on/off-the-run Treasuries as it will be a small issue (at least at first). On/off-the-run Treasuries are currently about five bps cheap to the interpolated 20-year yield. The 20-year benchmark trading 5-10 bps cheap to the interpolated curve is still not enough, however, to make the current 20yr/30yr spread curve in the index become upward sloping.
Key Takeaway
With a new 20-year Treasury benchmark, I expect to see more corporate issuance in this tenor. At the same time, demand is likely to absorb the supply easily. The index G-spread inversion indicated in this week’s chart is largely a function of the index makeup and the use of an interpolated 20-year Treasury level. As the index sees less liquid high-dollar bonds roll out of the tenor, I expect the 20yr/30yr G-spread inversion to lessen and ultimately become modestly upward sloping over time. We have seen this scenario play out in a number of recent 20-year corporate bond issuances.
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