US debt sale plan benefits from Fed 'no more pain'

(Bloomberg) — The U.S. Treasury Department plans to keep long-term debt sales steady this week in a new plan, with the government expected to get quick relief from the Federal Reserve's rapid reduction of its securities holdings.

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Dealers expect the Treasury Department to follow January guidance on Wednesday to delay further increases in the so-called quarterly redemption auctions – which are now approaching record Covid crisis sizes. That would mean $125 billion in auctions of longer-term securities next week.

Borrowing needs have escalated thanks to a yawning federal budget deficit and the Fed's quantitative tightening program — which has wiped up to $60 billion of Treasury bonds from the central bank's balance sheet, forcing the government to sell more to private sector buyers. The Fed will provide an update on its plans on Wednesday, after officials suggested in March that they could soon slow the pace of the QT.

The government bond market could use help.

U.S. Treasuries were heading for their biggest monthly loss since 2022 as of Thursday's close, hit by sharp inflation data that sharply curbed expectations for Fed rate cuts and inflated auction sizes. Selling of longer-term securities surprised traders two weeks ago with weak demand despite higher yield levels.

“I'm not so sure all of this helps Treasurys as much as it doesn't hurt them anymore,” said Michael Pugliese, a senior economist at Wells Fargo & Co., referring to the Fed's QT tapering and a stabilization of plans for the sale of government bonds. “Issuance is still very high and we are learning – kind of in real time – how well these auctions will be digested.”

Pugliese is among a number of Fed watchers who expect the central bank to announce a QT taper to begin in June. Chairman Jerome Powell, who will hold a news conference Wednesday after the Fed's policy decision, said in March that the tapering process would begin “fairly soon.”

QT focus

The Treasury Department's quarterly funding estimates, due to be released in Washington on Monday afternoon, underscore investors' focus on supply and are gaining increasing attention. Thanks to solid jobs and economic growth, tax revenues have risen sharply recently, improving the budget deficit in the short term. By January, officials had booked $202 billion in net debt for the three months through June.

Debt managers have been keeping a close eye on the Fed's plans and polling dealers about their own expectations for the Fed QT in a survey ahead of the redemption statement – ​​which comes just hours before the Fed's release.

Tom Simons, a senior economist at Jefferies, predicts the Fed will cut Treasury issuance in half, starting immediately after Wednesday — at a pace of up to $30 billion a month. Simons said it is unclear whether Treasury debt managers will factor the likely Fed QT changes into Monday's quarterly funding estimates.

It is unlikely at this point that there will be any relief on the interest rate front. With the cost of servicing the federal government's debt on track to reach a record high as a share of GDP next year, high inflation rates mean Powell and his colleagues are unlikely to signal rate cuts in the coming months.

Rate debate

Swap traders are pricing in only about 33 basis points of Fed rate cuts for all of 2024, compared to the more than six quarter points expected at the start of the year. On Wednesday, the Fed is seen keeping its policy rate steady at 5.25% to 5.50% – where it has been since July last year.

“The biggest change in language will come from Powell's messaging at the news conference,” said Lindsey Piegza, chief economist at Stifel Financial Corp. short-term interest rate reduction. While we won't overreact to it, the inflation numbers are moving in the wrong direction.”

This means that investors face tough auctions in a still inflationary environment.

Auction sizes for several tenors just hit new records. With interest rates not far from 5% across the maturity spectrum, investors have favored shorter-term government bonds, as evidenced by last week's sales, which went off without a hitch. But demand for 10-year bonds was seen as terrible earlier this month, while demand for 30-year bonds was lackluster.

Next week there are 3-, 10- and 30-year auctions scheduled, which form the payback group.

A $125 billion plan this time would mean the following auction formats with refundable amounts:

  • $58 billion in 3-year notes on May 7

  • $42 billion in 10-year notes on May 8

  • $25 billion in 30-year bonds on May 9

New three-year bonds are auctioned every month, and they have already been canceled by the Ministry of Finance in March and April by a total of $4 billion.

Dealers expected variable rate debt levels to remain stable over the next three months.

Sales of Treasury Inflation-Protected Securities, or TIPS, are the only type of debt forecast by dealers to see any increase. HSBC Holdings Plc expects the Treasury Department alone to lift the reopening auction of five-year TIPS in June by $1 billion. At JPMorgan Chase & Co. their strategists see bumps for TIPS via a $1 billion raise in July's new 10-year issue.

Dealers are also seeing U.S. debt managers starting to move away from relying on accounts, which mature within a year and pay no interest. The Treasury Borrowing Advisory Committee, a panel of market participants, has recommended the share of total debt in the range of 15% to 20%. This is also true because the Treasury Department has room to reduce its cash balance, which now stands at more than $900 billion.

Read more: Wall Street sees fewer T-Bills in April amid tough tax season

Dealers will also be looking Wednesday to find out the exact date for a long-awaited Treasury program to buy back existing debt. The initiative is intended in part to support market liquidity, and also to assist with cash management, smoothing out some of the fluctuations in bill issuance associated with high tax revenues.

Most dealers expect the first buybacks to take place in May. The Ministry of Finance last bought back shares between March 2000 and April 2002.

Bond investors will also have to deal with a tough set of economic data in the coming week. There will be reports related to the housing market, consumer confidence and industrial activity, but most important for investors will be a better understanding of the state of the US labor market. Vacancies for March will be interesting, but the most important thing is the release of non-farm payroll figures for April on Friday.

As for the Fed, in addition to Powell on Wednesday, New York Fed President John Williams and Chicago Fed President Austan Goolsbee will also speak on Friday.

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