A record amount of zero-coupon bonds were created in December as investors scrambled to lock in US government bond yields that were retreating from multiyear highs.
About $13.4 billion of zero-coupon Treasuries were created in December, the biggest monthly total ever, data released by the Treasury Department late Friday show. The previous milestone was $12.2 billion in October 2018 — also following a surge in yields.
Strong performance by US equities — the S&P 500 gained 24% last year, while the Nasdaq 100 Stock Index rallied to fresh all-time highs and closed up nearly 54% — helped drive demand for zero-coupon bonds by incentivizing pension funds to lock in those gains, interest-rate strategists at JPMorgan Chase & Co. said in a Jan. 5 report.
“There was room for pension funds to increase fixed income allocations,” and managers apparently “felt more comfortable adding fixed income exposure as yields turned,” the JPMorgan team led by Jay Barry wrote.
Zero-coupon bonds are created by dealers, not by the Treasury Department. The process involves selling the future cash flows — principal and interest — that comprise a conventional Treasury note or bond as individual securities, at a discount to their final value. Similar to how Treasury savings bonds work, an interest rate is imputed by the size of the discount and the time to maturity. With no coupon income to be reinvested, they fare best when prevailing market yields decline and worst when yields rise.
Yields on 30-year Treasuries — which are most frequently used to create Strips, an acronym for Separate Trading of Registered Interest and Principal of Securities — topped 5% in October for the first time since 2007. They’ve since declined to under 4.25% amid signs that economic growth slowed during the fourth quarter, possibly setting the stage for the Federal Reserve to cut interest rates this year.
The increase brought the total amount of Treasury Strips to a record of nearly $474 billion. By historical standards it remains a relatively small share — less than 2% — of Treasury debt outstanding, which exceeds $26 trillion. As recently as 2008 Strips’ share of total Treasuries outstanding exceeded 4%.
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