Bond Traders Spy Opportunities in Big Supply-Demand Shift Ahead

U.S. Treasuries are on the cusp of a major shift in the supply-demand dynamic that’s shaped the market for more than a year, potentially heralding opportunities for traders lamenting an extended stretch of limited volatility.

First, supply: Even if Congress passes infrastructure spending, Treasury auctions have grown bigger than they need to be, and cuts are expected as soon as next month. As for demand, the Federal Reserve, which has bought nearly $3 trillion of Treasuries since March 2020 to support the economy, is poised to start tapering its purchases also as soon as November.

The net impact on how much U.S. government debt the market will have to absorb — it’s likely to be smaller in 2022 is only part of the story. The key reason Wall Street sees possible market distortions ahead for traders to pounce on is that the changes may unfold independently, and with less predictability when it comes to the Treasury’s issuance plans.

“We are more sure of the timeline for the Fed’s taper than for Treasury’s coupon-auction cuts,” said Steven Zeng, a rates strategist at Deutsche Bank AG. “There’s pros and cons to Treasury starting cuts in November or waiting until February. This uncertainty will provide some relative-value trading opportunities along the yield curve, probably most particularly around the 20-year point.”

Traders are bracing for this shift as markets globally are reckoning with an elevated pace of inflation that’s testing the Fed’s resolve to keep rates low until the labor-market recovery progresses further.