Ball For Higher US Yields Is Back In Treasury's Court

By Simon White, Bloomberg Markets Live reporter and strategist

Yields and risk assets face rising risks from the Treasury Department’s borrowing report Wednesday.

The BOJ’s underwhelming move today has taken some of the pressure off global rates, with US 10-year yields lower on the session. That puts the ball back in Treasury’s court on whether yields resume their upwards trend this week, with the remainder of its quarterly refunding announcement on Wednesday.

We got their borrowing estimates on Monday. The total was lower than expected, but it is still the largest amount borrowed in the fourth quarter. However, it’s the split between bills and bonds (by bonds here I mean all debt more than one-year maturity) that has the most significant near-term implications for liquidity and longer-term yields.

Issuance has been skewed towards bills this year, which has limited the liquidity impact on risk assets as money market funds (MMFs) have been able to absorb them by using inert liquidity already parked in the reverse repo (RRP) facility at the Fed. But bills are now over 20% of total debt outstanding, normally towards the higher end of where the Treasury prefers it.

The Treasury has stated it will remain above 20% for now, but it will gradually skew issuance away from bills. MMFs cannot directly buy longer-term debt, so the buying will shift to higher-velocity holders of reserves, e.g. households. This will extract liquidity from of the system, leaving stocks and other risk assets more vulnerable.

The Treasury’s account at the Fed (the TGA) will be increasingly pivotal here. Treasury aims for this to be $750 billion at the end of 4Q and 1Q (it’s ~$850 billion at the moment). Currently it is de facto backed by bill issuance.

But if its size is maintained as the Treasury expects and issuance moves away from bills, or the RRP becomes too low, then it will be increasingly backed by longer-term debt that will deplete higher-velocity reserves and pose a serious headwind for risk assets.