(Bloomberg) — Treasury investors who have had to contend with a slew of issues over the past year are now preparing to face the opposite challenge: a slump in sales that leaves them awash with cash at work elsewhere must be put.
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The government is expected to announce further cuts to government bond issuance for the period May to July on Wednesday. Bank of America Corp. expects a net supply of $401 billion in T-bills for the second quarter. Wells Fargo & Co. sees a $321 billion reduction, while Goldman Sachs Group Inc. is looking for $250 billion fewer bills.
Traders are wary that the dwindling number of available notes is falling far short of demand, roiling money markets. It’s a mismatch that led investors two years ago to park trillions of dollars in a key Federal Reserve facility. This time, the path for the central bank to end its balance sheet tightening risks being clouded.
“We think there is a real risk of an acute supply-demand imbalance on the front end, where demand will exceed supply,” said Mark Cabana, head of U.S. rates strategy at Bank of America. “It’s baffling because it begs the question of ‘Who is going to buy the entire state stock?’ logic turned upside down.”
Tapping supply
The reduction in the supply of T-bills in the US started earlier this year. After selling a flurry of securities in the second half of 2023 following the resolution of the debt ceiling debate, the government has scaled back its issuance plans in anticipation of a strong fiscal push.
Negative net issuance totaled $196 billion this month alone, compared with the Treasury Department’s forecast of $100 billion to $150 billion in banknote sales cuts for April. The Ministry of Finance does not set precise issuance plans for banknotes so that it can adjust to the gaps created by the supply of coupons.
Higher tax revenues from a booming economy and lower borrowing due to a smaller deficit are among the reasons cited by banks predicting a further reduction in banknote issuance. While second-quarter Treasury estimates released Monday came in $41 billion higher than U.S. debt managers indicated in January, the Treasury Department’s estimate did not take into account a widely expected slowdown in the Fed’s tapering of Treasuries.
Tom Simons, a senior economist at Jefferies, forecast a $269 billion reduction in Treasury issuance for the current quarter, adjusted for the latest borrowing estimate. Bank of America’s Cabana kept his forecast unchanged, but noted that the higher government borrowing estimate posed a risk to the view that bill payouts will be as large as forecast.
“It’s worth watching,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA, who forecast a $220 billion drop in note sales in the current quarter after the latest loan review. “Especially at a time when there is quite a bit of investor demand for front-end products.”
Money market funds — which typically hold government bonds in addition to other short-term securities — rose to a record $6.1 trillion this month, as a stronger economy and persistent inflation prompt Fed officials and the market to rein in expectations for rate cuts this year hold. increase their appeal.
It is expected that the demand for government bonds from these funds will also increase. A coming rule change will encourage moving capital toward a specific type of money market fund that buys almost exclusively government bonds, and away from funds that also invest in higher-risk assets such as commercial paper.
QT Curveball
So where does all the money go? Historically, a shortage of short-term assets has sent money to the Fed.
Utilization of the Fed’s reverse repurchase agreement – a barometer of excess liquidity for the funding markets known as RRP – topped $2 trillion in mid-2022, as the money generated by the pandemic’s massive stimulus and quantitative easing the Fed was looking for a home.
Funds parked at the facility remained around that level until last year’s glut of Treasury issuance prompted most of them (about $1.75 trillion) to exit between June and April.
That drop in excess liquidity focused attention on how far the Fed can shrink its balance sheet, a process known as quantitative tightening, before funding markets begin to crack. Chairman Jerome Powell said in March that the Fed would begin shortening the QT interval “fairly soon”; Traders are looking forward to further details from Wednesday’s Fed meeting on when that will begin.
If thwarted T-bill investors put their money into the RRP, it could muddy the waters for ending QT by depriving the central bank of a clear view of liquidity. The Fed has said it is monitoring the RRP because it determines whether the market has sufficient liquidity.
“In terms of the Fed’s QT, using this logic, you might be able to argue that they should extend the QT longer in light of this supply-demand imbalance,” Bank of America’s Cabana said.
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