A $1.8 Trillion Bond Glut Imperils Treasuries’ Seven-Year Rally

The era of swelling Treasury auctions may be over for now, but investors are still about to absorb a historical deluge of long-term debt next year, with potentially painful implications for returns.

The math is simple: The Treasury is skewing its issuance more toward longer maturities, easing back on the bill sales it relied on in 2020 to pay for pandemic relief. At the same time, the Federal Reserve is likely to buy significantly less of the government’s debt on the secondary market in 2021, after hoovering up a massive amount this year to buoy the economy and keep markets functioning smoothly.

For JPMorgan Chase & Co., the biggest U.S. bank, the bottom line is that investors are going to have to soak up a lot more coupon-bearing Treasuries in 2021, to the tune of a net $1.84 trillion after taking into account the Fed’s buying. That’s an unprecedented annual amount, and it’s a staggering turnaround from this year, when a net $441 billion was sucked out of the market by JPMorgan’s calculation.

With such a big supply-demand shift ahead, yields might typically tend to climb, yet Wall Street sees only a modest march higher. That’s in part because there’s plenty of appetite internationally, given the world is awash in roughly $18 trillion of negative-yielding bonds, and the Fed’s Treasuries purchases, while reduced from 2020, will also still be a force. But with rates -- and coupon payments -- so low, even a small decline in Treasuries prices risks ending investors’ seven-year streak of positive total returns.

“The fact that the net Treasury duration hitting the market will almost double next year to a record is one key part of our calculus for yields,” said Jay Barry, a strategist at JPMorgan. “This combined with our expectation that economic growth will average an annualized 5% after the first quarter will push long-term yields higher,” though the increase will be restrained because of the Fed’s ultra-loose rate policy and investor demand for Treasuries.

Duration is how investors typically measure the impact on their portfolios from this sort of supply-demand swing. It’s a gauge of how much a bond’s price moves relative to changes in its yield -- the longer it is, the greater the price impact. So the net result is that portfolios will be more vulnerable to higher yields in 2021.