While the US Treasury had previously warned it would gradually increase TSY auction sizes, bond traders were looking to today's Refunding statement for details on when and how much this increase would be. We got the answer moments ago, when the Treasury unveiled it would increase auction sizes for 3, 10 and 30 Year maturities and will increase other maturities, FRNs over the quarter.
Specifically, the Treasury will offer $66 billion of Treasury securities - up from $62 billion last quarter - to refund approximately $46.6 billion of privately-held Treasury notes maturing on February 15, 2018. The securities are:
- Treasury to sell $26b of three-year notes vs $24b in Nov.
- Treasury to sell $24b of 10-year notes vs $23b from Nov.
- Treasury to sell $16b of 30-year bonds vs $15b Nov. level
Why is this important? Because it goes to supply, of which there will be plenty in 2018, in fact as Goldman calculated earlier this month, net Treasury issuance is set to double from $488BN to over $1Tn this year. And if there isn't enough demand, it will mean that rates have to rise, perhaps sharply.
As a reminder, in November 2017, the Treasury announced its intention to adjust auction sizes in order to respond to increased borrowing needs resulting from the change to the Federal Reserve’s reinvestment policy for its System Open Market Account (SOMA) portfolio as well as the fiscal outlook.
As such, Treasury announced modest increases to nominal coupon and 2-year FRN auction sizes beginning in February. Additional seasonal borrowing needs will be addressed through changes in regular bill and/or cash management bill auction sizes.
So, over the next quarter, Treasury anticipates increasing the sizes of the 2- and 3-year note auctions by $2 billion per month. As a result, the size of 2- and 3-year note auctions will increase by $6 billion by the end of the quarter.
In addition, Treasury will increase the auction size of the next 2-year FRN auction by $2 billion in February. Finally, Treasury will increase auction sizes by $1 billion to each of the next 5-, 7-, and 10-year notes and the 30-year bond auctions starting in February. All changes are applicable to subsequent new issues and reopenings. In total, these adjustments will result in an additional $42 billion of new issuance for the upcoming quarter. Auction sizes for TIPS will remain unchanged over the next quarter. TIPS continue to be an important product in Treasury’s debt issuance portfolio, and Treasury is fully committed to the TIPS program.
As the Treasury further adds, it "anticipates these changes will stabilize the weighted-average maturity (WAM) of the debt outstanding at or around current levels, notwithstanding large, unexpected changes to borrowing needs." It will also assess the need to make further adjustments to auction sizes at the next Quarterly Refunding in May based on projections of the fiscal outlook.
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Separately, the Treasury Borrowing Advisory Committee agreed at its Jan. 30 meeting that while the U.S. should put emphasis on increasing the size of auctions for shorter-dated coupon-bearing securities, issuance at the long-end “should also be adjusted, just to a lesser extent,” resulting in a weighted-average maturity around the current level, minutes of the gathering showed.
The committee defined short-end as 2- to 5-year nominal tenors, adding that increases in floating-rate notes also considered to be appropriate.
Deputy Assistant Secretary Clay Berry said Treasury intended to announce increases in coupon sizes “but that flexibility will need to be maintained over the coming months and quarters,” given that current budget estimates hadn’t been released, and depending on further funding needs.
The TBAC recommended further study of a potential 2-month bill and possibility of additional settlement date at next quarterly refunding.
The TBAC also suggested further study of the TIPS program “was warranted in terms of new issuance needs” and topic of potential increases in issuance should be revisited. The full powerpoint can be found here.
A presenting member suggested TIPS issuance should remain at ~7% of gross issuance, which would allow for up to $26b in additional supply over next year or so; should consider 5Y tenor for addressing new issuance, based on “solid demand and liquidity in that sector.”
The committee also discussed the difference between primary dealers’ projected net borrowing and the net borrowing assuming that Treasury does not change current issuance. In FY 2018, the remaining “funding gap” is projected to be $372 billion, which includes the expected $175 billion reduction in Treasury holdings in the Federal Reserve’s System Open Market Account (SOMA). In FY 2019, the funding gap is projected to be $882 billion, of which $287 billion is attributed to SOMA reductions.
In a surprising twist, while the market initially reacted with the long-end selling off after the Treasury announcement, it has since been aggressively bought, and was at sessions lows, around 2.94% at last check, suggesting that the market may have been expecting even more near-term supply.