–‘Year End Financing Rates Ate Expected to be Volatile Again’
US TSY DEPT (MaceNews) – The private-sector Treasury Borrowing Advisory Committee warned the department Treasury bill “scarcity” could develop with implications for the money markets where the Federal Reserve is offsetting liquidity pressures with T-bill purchases, according to documents released by the Treasury Department Wednesday.
The refunding announcement of financing details was as expected and was accompanied by an “as is” historical pattern of bill issuance and a statement that while there are no changes ready for announcement, various proposals may be announced later, including a 20-year bond.
The offering of $84 billion in securities to refunding approximately $60.5 billion will raise new cash of approximately $23.5 billion.
The department said it is taking a “proactive approach” to prepare for prospective future financing needs, “exploring” a possible 1-year SOFR linked floating rate note, a 20-year and a 50-year nominal coupon bond.
“Analysis and market outreach “is ongoing” to “inform any future issuance decisions.” The department also provided considerable data and analysis supporting the debut of the 20-year. The department promised to provide “ample notice” of any issuance changes.
In Treasury’s minutes of its meeting Tuesday with the advisory committee, the 20-year bond was seen by T-BAC s initially pricing “with a slight concession to fair value” and “could richen over time as the point becomes established, but could still appear costly compared to 10 and 30-year maturities on a duration weighted basis.”
The following is an excerpt of T-BAC’s report to Treasury, with boldfaced
emphasis added:
For Q2 FY 2020, the net privately-held marketable borrowing need is estimated to be larger at $389 billion, with a cash balance of $400 billion at the end of March. It was noted that privately-held net marketable borrowing excludes rollovers of Treasury securities and Treasury Bills held in the Federal Reserve’s System Open Market Account (SOMA), but includes financing required from the private sector due to SOMA redemptions. Secondary market purchases of Treasury securities by SOMA do not directly change net privately-held marketable borrowing, but when they mature would increase the amount of cash raised for a given privately-held auction size by increasing the SOMA “add-on” amount.
Based on current fiscal projections, and coupled with the Federal Reserve’s recently announced T-Bill purchases, it is possible that scarcity could develop in the T-Bill market if Treasury maintains its current coupon issuance sizes. Barring any change in issuance pattern, the Committee would expect to see a greater divergence in money market rates across T-Bills, CP, Fed Funds, SOFR and term repo rates. Additionally, year-end financing rates are expected to be volatile again owing to regulatory capital constraints primarily on the global systemically important banks (GSIBs).
The Committee discussed at length the benefits and concerns of altering coupon issuance in light of recent Fed actions, including review of a scenario with 2- and 3-year issue sizes dramatically smaller to maintain the size of privately-held T-Bills. While smooth market functioning and adequate supply of T-Bills are vital, given current fiscal projections of increased borrowing needs in 2021 and 2022, and in keeping with Treasury’s regular and predictable issuance strategy to provide the lowest cost to the taxpayers over time, the Committee recommended keeping coupon issuance sizes unchanged for this quarter. Based on current fiscal projections, and in line with the August recommendations, the Committee expected little or no change to nominal issuance for much of FY 2020, but noted that FY 2021 could require further coupon increases. Finally, the Committee recommended continued close monitoring of developments in Treasury and Treasury funding markets, given expected changes in size and composition of the SOMA portfolio. We discussed the Committee’s prior recommendation that between one quarter and one third of the financing gap be met with T-Bill issuance. While this quarter’s issuance will fall meaningfully below that target, (17%) the group expected Q2 FY2020 to be meaningfully above the target (39%). All agreed that the guidance was intended as a medium term goal to help increase the share of T-Bills outstanding over time, rather than a quarter-by-quarter directive. Given that T-Bills now represent 14.5% of debt outstanding and FRNs a further 2.5%, the Committee suggested future review on the appropriate share of variable rate debt taking into consideration projected interest expense, a potential SOFR FRN, and overall market functioning.
Market demand for TIPS remained healthy amidst the recent change in issuance pattern, including the very well received inaugural October issuance of 5- year TIPS. The Committee recommended leaving TIPS issue sizes unchanged given the $21 billion increase in TIPS supply for calendar year 2019, which was within the recommended $20-30 billion increase for the year.
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 any changes in funding needs and to accommodate historically large auction sizes. Members agreed that decisions taken to date afford Treasury significant flexibility to respond to potential changes in fiscal projections or Fed policy including potential further changes in the SOMA portfolio size and composition. The Committee continued its evaluation of new products by reviewing a charge on expected demand for a 20-year Treasury. The presenter expected such an issue would be met with robust demand from corporate pensions, insurance companies and others, but would find less demand from foreign buyers at auction. Overall, the Committee expected meaningful demand for a 20-year point in the curve across the broad investor base. Further, a new point on the curve could be a cost effective way to help meet projected increases in borrowing in 2021 and 2022.
The committee debated expected pricing at length and whether a 20-year would create a hump in the yield curve as was the case in the 1980s when 20-years were last issued. On net, we agreed a 20-year point could be a positive addition to Treasury’s issuance tool-kit, but more review was warranted on expected pricing, sizing, and sustainability of demand before drawing a final conclusion.
Respectfully,
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Beth Hammack Chair,
Treasury Borrowing Advisory Committee
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Daniel Dufresne Vice Chair,
Treasury Borrowing Advisory Committee