Latest News

McGeever: The 100 billion dollar Treasury record that you missed.

For good reason, the recent spike in 30-year bond yields has dominated world bond markets. With so much focus on the long end, it seems that few have noticed the historic changes in the ultra-short U.S. Treasury Market.

The weekly sale of four-week T bills has now reached the landmark of $100 billion. The September 4 auction marked the fifth consecutive sales at this record-high amount.

This new government strategy is reflected in the flood of bills being sold. The Trump administration wants to reduce interest rates and the debt maturity profile of the country by borrowing at the short end of the curve.

It seems to be working so far.

Investors expect at least 150 basis point of rate easing before the end of this year.

This is not only bringing down short-term rates, but also longer-term yields. The benchmark 10-year rate is at its lowest level since the 'Liberation Day tariff chaos' in April, and the 30-year rate is once again slipping away from 5%.

Investors who lend to Uncle Sam over a period of 10 years with the associated risk get paid 4.08% annually, while those who lend to Uncle Sam in a four-week period receive 4.20%. These bill auctions are generating strong demand. Last week's $100-billion sale was 2,78 times oversubscribed.

What's the issue?

Let me Roll It

The greatest concern is the 'rollover risk'. The government must refinance large portions of its debt more often because it concentrates sales on the front of the curve. It is then more vulnerable to unexpected financial, political or economy shocks. These could lead to an increase in short-term borrowing rates or force the Fed's policy rate to be raised.

Fed expectations may be skewed downwards right now. But what if inflation expectations start to rise and the Fed is forced to stop its easing cycle, or even raise rates?

This is not a crazy scenario. Goldman Sachs says the Fed is likely to ease in a climate of 3% inflation, high equity markets and the most accommodative financial conditions for three-and-a half years. The Atlanta Fed's GDPNow model also predicts 3.5% economic growth. The full impact of Trump's new tariffs on inflation is not taken into consideration.

The increased bill issuance is well-absorbed, but the cash that goes into them depletes liquidity pools and buffers elsewhere in the system. The overnight reverse repo facility of the Fed is almost empty and total bank reserve at the Fed is declining.

Nobody knows the minimum level of comfortable reserves in the banking system. In late 2019, a sudden fall below this level caused significant volatility in the money markets and an increase in overnight rates.

Experts believe that it is higher now, due to the expansion of the banking system and economy. Reserves are decreasing steadily and may soon fall below $3 trillion. Citi analysts warn that they will continue to "march" below this level as Tbill issuance increases, putting pressure on repo and funding costs.

THRESHOLD

According to Wall Street estimates, the Treasury is increasingly relying on T-bills as a funding source. This could mean that new issuances over the next 18 month may exceed $1.5 trillion.

The share of outstanding bills is also likely to increase. This percentage is currently just under 21 percent, which is slightly below the average historical level of 22.5%. However, it is above the range of 15-20% recommended by the Treasury Borrowing Advisory Committee.

T Rowe Price analysts believe the share will soon reach 25%. This is a level that was last seen during pandemics and the Global Financial Crisis. It suggests borrowing policies seen before crises may become the norm.

All of this won't be a problem as long as the demand for increased issuance is strong.

There's good reason to think that this will be the outcome. Money market funds, the largest buyers of T-bills, have seen their holdings explode from $4.7 billion in early 2020 to over $7 trillion today. There is also a massive demand for T-bills from stablecoin issues, who want to back their crypto assets using safe and liquid assets such as T-bills.

The market may continue to "play ball" with the new government funding strategy. The Trump administration is hoping so, with over $1 trillion in new issuances coming.

(source: Reuters)