In a time when the Fed's QT is expected to soak up sloshing investor liquidity, while the end of Fed TSY buying (and phased out rolling of maturities) is meant to lead to a (gradual) increase in Treasury auction sizes, today's quarterly refunding announcement by the Treasury was counterintuitive, because instead of boosting the size of auctions across the curve for August and futures months, the Treasury reduced its quarterly sale of longer-term debt for a fourth straight time (in line with expectations) and laid out plans for cuts to a range of maturities in coming months, with the 20-year bond - which has long been "kinked" on the curve and paying a higher yield than even 30Y paper - singled out for the biggest trimming.
The Treasury Department said in a statement in Washington that it will sell $98 billion of long-term securities at its so-called quarterly refunding auctions next week -- down from May’s $103 billion. According to Bloomberg, this marks the longest string of declines in about eight years. The offering sizes are as follows:
- $42 billion of 3-year notes on Aug. 9, compared with $45 billion at the May refunding and $43 billion at the July auction
- $35 billion of 10-year notes on Aug. 10, compared with $36 billion last quarter
- $21 billion of 30-year bonds on Aug. 11, versus $22 billion in May
This issuance will raise $43.9 billion in new cash from private investors, which is a very modest number considering the trillions in excess liquidity floating around. Indeed, as Bloomberg also notes, the continued shrinkage in TSY auctions "rebuts the notion that the Fed’s QT is having an immediate impact in soaking up investor cash-- if SOMA redemptions were going to bite, they would result in higher issuance." Alas, that is not happening, since for now the Treasury has yet to decide whether and when it will need excess cash; meanwhile there are roughly $2.2 trillion in excess liquidity parked at the Fed's O/N Reverse Repo facility.
"Since the May refunding, Treasury has continued to receive information regarding projected borrowing needs, including an additional quarter of tax receipts and clarity on the timing and pace of redemptions of Treasury securities from the Federal Reserve System Open Market Account. Based on this updated information, Treasury intends to continue reducing auction sizes of nominal coupon securities during the upcoming August – October 2022 quarter ", the Treasury said in its refunding announcement. "Treasury believes these reductions announced today leave Treasury well-positioned to address potential changes to the fiscal outlook. Depending on future developments in projected borrowing needs, Treasury will consider whether adjustments in future quarters may be appropriate."
The most acute auction cuts came at the 20 year tenor: the Treasury anticipates cuts of $2 billion to both the new and reopened 20-year bond auction sizes starting in August. According to the Treasury, market participant feedback in the past quarter has indicated that slightly larger reductions to 20-year bond auction sizes relative to surrounding maturities would improve the structural supply and demand balance at the tenor, but also noted that it was important to ensure benchmark liquidity size and that any adjustments be made in the context of Treasury’s regular and predictable issuance framework.
The Treasury said that feedback from market participants showed that slightly larger cutbacks to the 20-year than for other securities “would improve the structural supply and demand balance” for that bond. But the department was also told “it was important to ensure benchmark liquidity size.”
Some dealers had predicted even bigger reductions for the 20-year bond, given demand that’s been so low as to contribute to that security yielding more than both 10-year and 30-year Treasuries. Needless to say, as shown below, the Treasury needs all the help it can get in normalizing the curve.
As expected by dealers, the Treasury also announced it will keep boosting sales of inflation-linked debt. That’s as debt managers continue to work to stabilize TIPS, as they are known, as a share of total marketable debt outstanding.
“Treasury will continue to monitor TIPS market conditions and consider whether subsequent modest increases would be appropriate,” the department said.
And as for bills, the Treasury said its current projections show that July will be the low-point for outstanding supply. Debt managers have already boosted bills outstanding by $77 billion since then, and anticipate further lifting that by nearly $100 billion by the end of September. In line with previous plans, the Treasury expects its first benchmark four-month bill auction to be announced Oct. 18 and conducted the next day.
The Treasury also detailed cuts to nominal debt of other maturities over coming months, with the full breakdown laid out as follows:
Sales of 2-year, 3-year, 5-year and 7-year notes will each be trimmed by $1 billion per month over the next three months
- The new and reopened 20-year bond auction sizes will be scaled back by $2 billion, starting in August
- Both the new and reopened 10-year note auction sizes will be trimmed by $1 billion, starting in August
- Both the new and reopened 30-year bond auction sizes will be reduced by $1 billion, starting in August
The table below summarizes the anticipated auction sizes in billions of dollars for the August – October 2022 quarter.
The total amount of new money raised in fiscal Q4 is shown below:
“Treasury believes these reductions announced today leave Treasury well-positioned to address potential changes to the fiscal outlook,” the department said. “Depending on future developments in projected borrowing needs, Treasury will consider whether adjustments in future quarters may be appropriate.”
Wednesday’s announcement was in line with what a majority of dealers had predicted. Also as anticipated, the department said it will ramp up issuance of Treasury bills, which have been in high demand as investors flock to short-dated instruments amid economic uncertainty. July will prove the low-point for bill supply for the year, the Treasury said. Still, while bill issuance is set to increase by $123 billion in the current quarter and $59 billion next quarter, the amounts aren’t really going have a material impact on shifting liquidity from the RRP facility to Bills. Some more from the Treasury:
Based on current forecasts, Treasury expects that the supply of bills outstanding in mid-July will represent the lowest point for the calendar year. Since this low point, Treasury has increased bills outstanding by $77 billion and anticipates that supply will further increase by nearly $100 billion over the remainder of the current calendar quarter. As always, Treasury will continue to evaluate the fiscal outlook and assess the need to make adjustments to bill auction sizes as the outlook evolves.
As announced at the May quarterly refunding, Treasury plans to transition the 4-month (i.e.,17-week) CMB to benchmark status. During this transition, Treasury will continue to issue the 4-month CMB at a regular weekly cadence. Treasury anticipates that the first benchmark 4-month bill auction will be announced on October 18, 2022 and auctioned on October 19, 2022. As noted previously, Treasury intends to maintain the Tuesday settlement and maturity cycle for the 4-month benchmark bill.
Going forward, the Treasury gave no indication that further cuts to issuance of coupons are in store. The Federal Reserve’s continuing reduction of its holdings of Treasuries is putting the onus on the government to borrow more from private-sector buyers, leaving less room for such auction cuts, however as noted above that has yet to manifest itself in higher auction sizes.
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Appendix: 20Y Treasury
As noted above, the 20Y TSY remains a problematic point on the curve, yet the Treasury Borrowing Advisory Committee (or TBAC) recommended that the department should remain committed to the 20-year maturity point to achieve its overall issuance goals, and maintain its regular and predictable strategy, according to a statement to the U.S. Treasury Secretary from the committee following its Aug. 2 meeting.
As Bloomberg notes, the TBAC posited the imbalance in the 20-year sector was due to much larger than recommended issue sizes from late 2020 and 2021, and with the recommended further reduction, the tenor is “reaching the range of sustainable issuance size that should be better aligned with future demand”
The TBAC said its recommendation to cut the size of the 20-year auction (new issues and reopenings) by $2 billion would bring supply more in line with longer-term demand and help increase T-bill share close to the middle of the TBAC’s recommended 15%-20% range over time.
Over a longer horizon, issuance path is expected to keep the average maturity of Treasury debt and its average duration roughly unchanged, as well as leave the T-bill share of outstanding debt within the recommended 15%-20% range, and gradually increase the share of TIPS in outstanding debt.
Regarding buybacks, the TBAC was mixed on whether the benefits of improved liquidity in off-the-run securities outweighed the costs of larger new issue sizes and said the subject warrants further study.
Committee said one compelling sector to explore seems to be the front end of the market, where Treasury could buyback short coupons (within one year to maturity) and issue bills in replacement. This would allow Treasury to achieve liquidity premium benefits and enable improved cash management.
It was argued that Treasury shouldn’t try to construct buybacks as a tool for sustaining market functioning during times of acute stress, as purchases generally need to be funded by issuing other Treasury securities