(Bloomberg) -- A record amount of zero-coupon bonds were created in July as the Treasury market posted its biggest gain of the year in anticipation of Federal Reserve interest-rate cuts beginning in September.
About $14.7 billion of zero-coupon Treasuries were created, data released by the Treasury Department late Tuesday show. The previous milestone was $13.4 billion in December — also amid a market rally.
Demand for zero-coupon bonds, which deliver the most bang for the buck in a market rally because there’s no coupon income to be reinvested, rocketed at a time of year when it normally sags, Barclays strategists Andres Mok and Demi Hu said in a report.
Strong inflows into bond funds over the same period also are indicative of economic concerns leading investors to favor bonds over stocks, they wrote. Exchange-traded bond funds netted a record $39 billion in July.
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.
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 — peaked last month at around 4.65% on July 1. They dropped to 4.30%, the lowest level since March, on the last day of the month when Fed Chair Jerome Powell said it was possible the central bank would begin easing in September.
The increase in zero-coupon bonds brought the total amount of Treasury Strips to a record of $515 billion. By historical standards it remains a relatively small share — less than 2% — of Treasury debt outstanding, which exceeds $27 trillion. As recently as 2008 Strips’ share of total Treasuries outstanding exceeded 4%.
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