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A spectre is haunting US bond markets — the spectre of fiscal dominance.
Wednesday will bring two big policy events: The Treasury Dept’s detailed refunding announcement, where it will announce its quarterly issuance plans by tenor, and the Federal Reserve’s monetary policy statement. Most market watchers believe the refunding will be more consequential for US debt markets. By definition, that puts fiscal policy (ie the Treasury) in the drivers’ seat.
But this isn’t really the “fiscal dominance” that lurks in the nightmares of monetarists. Few would say that Big Fiscal has grown so much that central bankers can’t control inflation. While one economist recently argued it’s “no longer far-fetched” and highlights the implications for banking policy, that’s a topic for another day. Presumably there’s also a risk of “monetary dominance”, where economic conditions are controlled entirely by unelected officials. It isn’t clear why that’d be a better state of affairs.
Anyway! The Treasury said Monday it will issue a net $776 billion in marketable debt for the current quarter. And for Q1 of next year, the Treasury “expects to borrow $816 billion in privately held net marketable debt.”
The most important part of the Treasury’s quarterly issuance plans will be Wednesday’s breakdown between maturities, however.
Remember when the Treasury boosted its issuance of coupon-bearing notes and bonds by more than expected in August? (Bills, in contrast, are sold at a discount and redeemed at par, with no need for coupons.)
That extra supply was a major driver of the recent selloff in long-dated Treasuries, along with expectations of “higher for longer” US policy rates.
As Barclays’ Ajay Rajadhyaksha writes today:
. . . in early August, markets were clearly surprised when Treasury not only announced higher funding needs, but also a plan to term out debt issuance at a faster pace. At that time, the TBAC noted in a letter that it was comfortable with the Treasury bill share of outstanding running at 22.4% “for some time” — Treasury’s advisory committee seemed clearly worried about the market’s ability to digest heavy coupon issuance.
Instead, Treasury chose to go in the opposite direction, surprised markets, and sparked a global bond rout. Since then, term premium is much higher, removing the economic argument for aggressively terming out debt. Several Treasury auctions have tailed since August. And especially in October, poor auctions have been catalysts for renewed bear steepening seemingly every week. Last week, for example, the 5y auction tailed 2bp, only to spark yet another large rise in longer bond yields.
Goldman Sachs, who estimated a net $739bn of 4Q issuance on Friday (pretty close!), predicted that the increase in borrowing will be pretty evenly split between coupon-bearing debt and bills:
If the Treasury speeds up its coupon-bearing debt sales, it could drive the US yield curve to keep steepening (perhaps even un-invert 👀). More bill issuance would lead to a flatter curve. From GS:
We had flagged last week that Treasury would continue to increase coupon auction sizes this cycle and would be unlikely to aggressively tilt the maturity distribution of new issuance towards bills. That said, our forecasts already feature a moderately slower pace of size increases for the current cycle compared to the prior cycle, which in turn means a heavier lean towards funding via bill issuance versus consensus. We believe that slowing in the pace of coupon auction size increases, were it to occur, would be more likely at long maturities and could result in the yield curve flattening following such an announcement. If Treasury continues to increase coupons at its previous pace, however, we could see the curve trade with a mild steepening bias in the aftermath.
Barclays’ Rajadhyaksha wrote Monday that he expects the US will slow down the ongoing extension of debt maturities after the recent selloff. With our emphasis:
Bill share is currently 20.4% of outstanding Treasury debt, and Treasury has a medium-term goal of getting it into the 15-20% range. But that is a loose target at best — without a time limit, and with a very wide range. Notably, in its 13 October survey, Treasury asked primary dealers how large bill auctions could reasonably get, suggesting that officials are at least thinking about a higher bill share in the near term. Treasury does emphasise being consistent and predictable in its issuance (and not opportunistic). But that is not at odds with a temporarily higher T-bill share.
Treasury would not do an about-turn on issuance; it would simply slow down the pace at which it is terming out, and that would be enough to raise the share of bills. The overall impact on coupon issuance is quite large. If Treasury commits to having bills at 23% of outstanding by the end of 2025, for example, markets are looking at $900bn less in coupon issuance over that time period. In other words, substantial supply relief, if we are right.
Our view is nothing more than an informed ‘guess’, of course. Some clients have suggested that Secretary Yellen’s insistence last week that the rise in longer yields is due to a strong economy is a signal that bill share will keep dropping. We disagree. Higher term premium, persistent auction tails, TBAC’s implicit blessing and the primary dealer survey question suggest to us that the conditions are in place to signal an increase in T-bill share temporarily, at the 1 November QRA.
In contrast, Bank of America’s strategists believe that the rising cost of government financing at higher interest rates means that the Treasury will continue to boost coupon-bearing debt sales:
. . . a major reason for our upward revisions are higher interest expenses. Assuming that market forwards are realized, gross financing costs from marketable debt will increase materially as a share of GDP in coming years. While net interest expenses will get some relief from the resumption in student loan payments, net interest expenses will account for an increasing portion of the overall deficit (Exhibit 12). Indeed, we expect net-interest expenses as a share of GDP to increase from 2.5% in FY 2023 to 3.5% in FY 2026, highest on record.
In other words, New Yorkers will probably want to log on well before the Fed’s 2pm statement Wednesday. The Treasury’s refunding details will be announced at 8:30am.
