WASHINGTON (MaceNews) – The private-sector Treasury Borrowing Advisory Committee’s recommendations to the U.S. Treasury, in preparation for Wednesday’s quarterly refinancing announcement, now favor bigger issuance increases in longer maturities. The following is an excerpt from the TBAC report:
The Committee discussed the elevated cash balance that Treasury has held in recent months and projects to hold for some time.Treasury explained that the higher cash balance resulted from the large and highly uncertain need for funds amid considerable uncertainty about the path of fiscal policyand the timing of the associated projected payments. TBAC members noted that maintaining a higher cash balance during this highly uncertain period was a prudent strategy, but that balances had far outstripped expectations, raising some questions in the marketplace.
Treasury’s approach has been precautionary given the significant risk of forecasting error in this unprecedented environment and its desire to be able to disburse funds quickly to support the economy. Treasury staff presented an overview of net issuance assuming coupon sizes remained the same as announced on FYQ3. In such case, net coupon issuance would be $447 billion and T-Bill issuance would need to increase by $500 billion to meet the projected financing need. At the end of June, private T-Bill holdings had increased to $4,754billion – a new all-time high – and T-Bills holdings as a share of marketable debt outstanding have risen to 25.5% – above the historical average of 22.7%.
Treasury staff highlighted that demand for T-Bills remained robust throughout the recent issuance,bid-to-cover ratios remained stable across the curve, and foreign demand increased modestly.Committee members agreed with that assessment, noting that the bill market had acted as a robust source of funding amid a rapidly changing fiscal environment. The Committee also noted that the new 20-year issuance has been well received by investors, despite its larger-than-expected initial size. Members noted that longer-term Treasury yields remained near historical lows amidst the current environment of continued expectations of low short-term interest rates and significant negative net supply of coupon securities year-to-date when accounting for Fed purchases. Still, members noted some pressure on long end yields as evidenced by swap spreads becoming more negative relative to late last year, possibly driven by expectations of increased long end issuance.Treasury staff reported that Treasury’s recent RFI indicated solid support for a 1-year SOFR FRN, with expected demand from money market funds and foreign governments. The Committee agreed with feedback that a SOFR FRN would support the transition away from LIBOR, as it would help to further establish market standards for issuance, encourage technological investment, support development of a term rate, and increase liquidity SOFR-indexed products.
The Committee was unanimously supportive of Treasury moving forward with a SOFR FRN, preferably relatively early in FY2021,and encouraged Treasury to finalize the design of the security and complete associated implementation efforts in a timely manner.The Committee next reviewed a charge on how Treasury should shift issuance to manage its maturity profile, given that the immediate funding needs related to the COVID-19 outbreak had been met primarily through T-Bill issuance. Given these issuance patterns, the maturity of outstanding debt has fallen notably, with about 37% of outstanding Treasury debt maturing within one year and 59% maturing within three years.The presenter reviewed debt management optionsin light of several key aspects of the current environment. In looking at this issue, the presenter partially relied on the macroeconomic outlook and TBAC’s debtissuance modelpreviously developed by several TBAC members, while noting that it is only one analytical tool to consider.
The presenter highlighted that several aspects of the current environment may make it desirable to extend issuance from shorter maturities into term securities, particularly ones with maturities out to ten years. Given the proximity to the zero lower bound on interest rates, issuance in the 5-to 10-year sectors is attractive to protect against rising rates and to realize desirable correlations between funding costs and the primary deficit. This conclusion was supported by the debt issuance model which had previously favored issuance in maturities 5-years and under. The presenter noted that increased TIPS issuance would also provide the Treasury with a useful hedge against weaker growth and higher deficits. While coupons will likely need to increase across the curve to accommodate historically large funding needs, several measures indicate that the term premium on long-term Treasuries remains elevated relative to the belly of the curve.
As a result, focusing the largest increases on issuance in maturities out to 10 years and in TIPS appears to be more desirable than concentrating issuance in longer instruments. The Committee member also noted that extending issuance into term maturities would mitigate some of the funding risk associated with any future decision by the Fed to run-off some of its SOMA holdings.
Lastly, the member argued that demand for T-Bills would likely remain elevated in the current environment, given the rise in private savings and the willingness of banks to substitute from reserves into T-Bills. As a result, the T-Bill market should continue to be an effective shock absorber for unexpected financing needs. Most members felt that, over time, Treasury should maintain the share of T-Bills outstanding within historical ranges, and not increase the overall share above those levels, in order to retain capacity for the T-Bill market to serve this role effectively.
The Committee discussed financing strategies to accommodate revised fiscal projections amidst continued fiscal and economic uncertainty owing to the COVID-19 epidemic. The Committee endorsed a gradual increase of coupon sizes in line with Treasury’s regular and predictable issuance strategy to achieve the lowest cost to taxpayers over time. The Treasury’s debt management decisions in May had placed a larger amount of issuance in longer-term maturities than recommended by TBAC at the time. While that issuance was met with robust demand over the quarter, Committee members noted that the supportive market conditions likely reflected several factors that may not be sustained over the intermediate term.
The Committee continues to recommend increases in issuance sizes across all maturities, but suggests that increases in maturities out to 10 years should be somewhat larger than increases in the long end. The Committee also recommendsmodest increases in TIPS issue sizes. These changes would allow Treasury to lengthen the maturity profile of its debt back to its pre-COVID levels by late 2022.Given the uncertainty inherent in fiscal projections and Fed balance sheet policy, Treasury will need to retain flexibility in its issuance path to respond to further changes in funding needs, market functioning and shifting demand preferences.
Respectfully,_
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Beth HammackChair, Treasury Borrowing Advisory Committee_
Daniel DufresneVice Chair, Treasury Borrowing Advisory Committee
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