U.S. comments from Morgan Stanley

UST Liquidity
The CTD bases, MSTVI index, and bid/offer spreads suggest liquidity in the UST market may be marginally worse in light of increased issuance and decreased Fed purchases.

Fed LSAPs
Since Friday, March 13, when the Fed began buying coupons, the Fed has bought ~$1.47tn with another $40bn planned for next week. Cover ratios and unfilled offers across the board have been increasing, suggesting dealers still have inventory to sell. The cover ratio in the 0-2.25y sector was by far the highest it’s been, suggesting dealer balance sheets are likely becoming constrained by increased T-bill and front-end issuance.

On the whole, liquidity in the Treasury market seems to have normalized. As such, the Fed has been tapering purchases over the last few weeks and will likely continue to do so.

UST CASH-FUTURES BASIS

As shown in Exhibit 7, CTD basis widened modestly across all contracts except the WN contract. We believe that Treasuries could come under a bit of pressure (particularly in the front end) as the market gears up for more issuance. In addition to increased bill issuance, the Treasury also increased auction sizes of 2-, 3-, 5-, 7- 10-, and 30-year issues by $2bn, $2bn, $2bn, $3bn, $1bn, and $1bn, respectively. We expect further increases beginning in the May refunding cycle.

The basis spreads across the board give us a sense of how cheap bonds are trading to futures. This cheapness reflects a higher cost of funding cash positions. On a running bp metric, the TU basis is widest, and widened 0.75bp today (running bp takes into consideration DV01 of the asset).Ā Note: as a proxy of the true CTD gross basis, we merely calculate the yield on the CTD less the yield on the future to give a relativistic sense of how these contracts are trading compared to cash.

Exhibit 7: Futures CTD basis (outright level in bp)

Source: Bloomberg, Morgan Stanley ResearchExhibit 8: Futures CTD basis (in running bp)

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