(Bloomberg) -- The Federal Reserve’s daily purchases of Treasury securities raised some eyebrows on Wednesday because in two of the four operations, bonds that were the cheapest-to-deliver into a Treasury futures contract were the most heavily bought.
Traders say it’s a good sign. The Fed’s purchase program began in mid-March with the aim of restoring liquidity in the Treasury market, which had eroded in particular for securities lacking any sort of distinction, such as being the most recently issued, otherwise known as “on the run,” or being cheapest-to-deliver into futures. Buying of CTDs suggests that other securities are no longer being offered as cheaply as they once were.
“They’ve bought so much off-the-run paper that the offerings are probably getting a little wide,” said Dan Mulholland, head of Treasury trading at Credit Agricole in New York. Dealers “can offer blocks of CTD closer to the market and just trade out of the basis, rather than short bonds to the Fed, which wouldn’t make sense.” The basis is the cash-futures spread, which has tightened, he said.
The development is consistent with the Fed’s decision to taper the size of its purchases to an average of $30 billion a day this week from $50 billion a day last week and a peak of $75 billion a day until April 1. Its purchases from March 13 to date total more than $1.25 trillion.
In its second operation Wednesday, the Fed bought $7 billion of securities maturing between 2024 and 2027. Among them was the 2.5% note due in February 2027, the cheapest-to-deliver into the June 10-year note futures contract. The Fed bought $4.85 billion; Tuesday, it bought $2.95 billion of the same note.
In its first operation Wednesday, the Fed bought $4 billion of securities maturing between 2040 and 2050, among them $1.1 billion of the 3% bond maturing in November 2045. The issue is cheapest-to-deliver into the June Ultra Bond contract.
In past years, Fed purchase programs as a matter of policy have excluded issues that are cheapest-to-deliver into futures. The current program, by contrast, included them beginning March 15. A New York Fed spokeswoman couldn’t immediately provide an explanation for the shift.
Wrightson ICAP chief economist Lou Crandall said CTD issues were excluded in the past to avoid giving dealers an opportunity to offload securities in a way that could distort other markets.
“A dealer could potentially move futures a lot by offering a marginal amount of the CTD at an attractive rate to the Fed,” he said. “However, in a world in which a lot of leveraged positions have been stopped out and dealers have had to absorb the underlying cash securities liquidated by accounts that were in basis trades, allowing dealers to show the CTDs through to the Fed seems reasonable.”
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