The upcoming 30-year US Treasury auction might rattle markets.

While Wednesday’s bidding metrics at the 10-year Treasury auction will be critical to understanding investors’ appetite for the US safe-haven in light of a strong economy, we expect the auction to receive substantial demand. Indeed, roughly $280 billion worth of US Treasuries will mature this month, freeing cash likely to be reinvested.

Roughly $66 billion of an old 10-year benchmark is coming to maturity this month. While it’s not guaranteed that proceeds from maturing bonds will be reinvested in the same tenor, it’s safe to assume that demand for the new-on-the-run benchmark will be robust and will benefit from upcoming maturities.

The New York Fed holds approximately $19 billion of the maturing 10-year tenor bond (US912828B667). Because the Federal Reserve doesn't participate in auctions, $46 billion, four billion above this week's US Treasury auction size, may be looking to reinvest proceeds into the upcoming 10-year note auction.

Problems arise when we look at the upcoming 30-year bond auction. The risk-and-reward profile the 30-year bonds provide makes them a directional bet on interest rates. For example, the on-the-run 30-year US Treasury bond paying a coupon of 4.75% and maturing in November 2053 pays a yield of 4.37% (ISIN: US912810TV08). Assuming a holding period of one year and yields dropping by 100bpp, the total return of this position would be 21%. Yet, if yields rise by 100 bps, the position will lose -10 %.

Additionally, assuming Yellen follows TBAC’s recommendation, The US Treasury would sell $306 billion in coupon notes and bonds in February. US Treasuries maturing this month amount to $280 billion, of which $77 billion are held at the New York Fed, which cannot participate in auctions (but can bid in the secondary markets although QT remains in place).

With no 30-year tenor maturing this month and the supply of Treasuries overcoming maturities, demand for this week’s 30-year US Treasury bond auction must come from investors seeking to extend their portfolio's duration.

The corporate bond market will compete with this week’s 30-year US Treasury bond auction.

This week's investment-grade corporate non-financial bond supply is expected to come between $25 to $30 billion. Such issuance is likely to compete for demand with the issuance of 30-year US Treasury bonds this Thursday for two reasons:

• Investment-grade corporate bonds offer a sizable pickup over 30-year US Treasuries. According to the Bloomberg USAgg Index, investment grade corporate bonds pay, on average, 4.67%, 40bps above 30-year US Treasury. That has only sometimes been the case. Since 2000 until today, 30-year US Treasury bonds have been paying a premium above the average yield paid by IG corporate thirteen years over twenty-three. Suppose the expectation of markets is one of a hard landing, hence stimulus. In that case, investors would be better positioned to hold corporate bonds, as corporate spreads have the potential to tighten considerably and yields to fall below 30-year US Treasuries as it happened in the past.
• Investment-grade corporate bonds are exposed to less duration risk. On average, Investment-grade corporate bonds have a duration of little over six years, making them less sensitive to shifts in interest rates.