–US Treasury’s Quarterly Refunding As Expected, Raises $26.7 Bln New Cash
WASHINGTON (MaceNews) – In their quarterly refunding announcements Wednesday morning, U.S. Treasury officials again said no decision has been reached on a SOFR 1-year floating rate note while the private-sector Treasury Borrowing Advisory Committee suggested it’s looking forward to it.
Treasury has said a floating rate note based on the SOFR rate, the global rate benchmark that is only slowly replacing the tainted Libor rate, would encourage adoption of the alternative, a massive enterprise central to debt issuance of all sorts.
Still senior Treasury officials said no decision on debuting issuance has been made and comments on the proposal are still invited.
In the U.S. floating rate notes linked to the Secured Overnight Finance Rate are primarily issued by the government-sponsored housing enterprises, with the Federal Home Loan Bank the primary issuer of the over $170 billion in issuance.
Libor remains the primary – by far – rate benchmark globally but self-interested manipulation by some commercial banks forced regulators worldwide to set its date of disappearance at the end of 2021, even though it is embedded in trillions of dollars of debt contracts.
Reviewing the proposal, the private sector Treasury Advisory Borrowing Committee told Treasury it expected “Treasury could price SOFR FRNs reasonably in line with or perhaps better than the existing T-Bill FRN pricing.”
Elsewhere in the quarterly refinancing announcements Wednesday, the composition of next week’s refunding auctions was as expected, with $38 billion in a 3-year note, $27 billion in a 10-year note and a 30-year bond of $19 billion.
Treasury said its financing requirements over the upcoming quarter will be met with weekly bill auctions, cash management bills, monthly note auctions and a TIPS reopening. There is expected to be no increase to nominal coupon and FRN auction sizes, in fact, no further changes in issuance sizes for coupon and FRNs “for the remainder of the 2019 calendar year.”
Treasury’s briefing for the Advisory Committee repeated that it is “well funded” for the rest of this fiscal year, ending Sept. 30, and “the first part of fiscal 2020. But it sees “significant funding gaaps” starting in FY2021, beginning in October of next year.
“The substantial increase in funding needs in FY2021 reflects, in part, large amounts of maturing 2-year and 3-year notes that need to be refinanced,” its statement said.
At the same time, the Federal Reserve’s reinvestment of its portfolios’ mortgage backed securities holdings into Treasuries and potential Fed balance sheet growth could reduce financing needs from the public by an additional $100 billion to $200 billion “annually over the next several years.”
Treasury is rebuilding its cash balance now that Congress has again suspended the debt limit as part of the two-year spending agreement. The accomplish the rebuilding, “the amount of bills outstanding is expected to gradually approach levels by September that are comparable to levels last seen in May,” Treasury said.
The TBAC members urged Congress to consider a total repeal of the statutory debt limit “well ahead of the proposed 2021 expiration of the suspension,” a proposal that has always gone nowhere on Capitol Hill which sees the debt limit has a point of leverage over borrowing, despite the fact it governs borrowing already irretrievably done. There have been seven suspensions of the debt limit in seven years, “increasing market volatility, operational risk and ultimately taxpayer cost,” the TBAC said.
Below is an excerpt from TBAC’s report to Treasury:
The FOMC has also indicated that an early end to balance sheet runoff at the upcoming July meeting is likely, with Fed officials strongly suggesting runoff will conclude should the FOMC deliver a rate cut. The balance sheet will thus likely remain steady at roughly $3.8bn until it begins growing again at a future date, although bank reserve balances will continue to shrink gradually due to the growth of non-reserve liabilities such as currency in circulation.
In light of this financial and economic backdrop, the Committee reviewed Treasury’s August 2019 Quarterly Refunding Presentation to the TBAC. FY 2019 year-to-date receipts were $68 billion (3%) higher than the comparable period in 2018. Increases in customs duties (due to new tariffs) and withheld income and FICA taxes, as well as lower refunds, were the largest drivers partially offset by a decline in Federal Reserve earnings due to higher short term interest rates and lower corporate taxes. Total outlays over the same period were $205 billion higher, an increase of 7% after calendar adjustments. Based on the Quarterly Borrowing Estimate, Treasury’s Office of Fiscal Projections currently projects a net privately-held marketable borrowing need of $433 billion for Q4 FY 2019, with an end-of-September cash balance of $350 billion, assuming the proposed debt limit suspension bill passes the Senate and is signed by the President. Treasury noted that this borrowing estimate implies about $160 billion of net bill issuance over the remainder of the quarter, or roughly half as large as the $330 billion increase in bills outstanding in March 2018 over a similar time frame.
For Q1 FY 2020, the net privately-held marketable borrowing need is estimated to be larger at $381 billion, with a cash balance of $410 billion at the end of December. It was noted that privately-held marketable borrowing excludes rollovers of Treasury securities held in the Federal Reserve’s System Open Market Account (SOMA), but includes financing required due to SOMA redemptions. The Committee also reviewed the path of expected growth of the SOMA portfolio assuming SOMA redemptions cease in September as originally planned. It was noted that if the SOMA redemptions ended shortly after the upcoming July FOMC meeting, that would reduce FY 2019 financing needs by approximately $28 billion.
Members were pleased that you were able to negotiate a debt limit suspension bill with Congress well in advance of the deadline and are optimistic that the bill will become law in short order. It was noted, however, that this would mark the 7th debt limit suspension in less than 7 years. As debt limit suspensions expire, Treasury has been required to employ extraordinary measures – increasing market volatility, operational risk and ultimately taxpayer cost. The Committee strongly believes that discussions on total borrowing are more appropriately considered when making appropriations rather than when funding previously approved appropriations. The Committee unanimously urged Congress to consider a repeal of the debt limit well ahead of the proposed 2021 expiration of the suspension.
Treasury reviewed the responses to the primary dealer questionnaire. On balance, dealers expected that the Bill supply would increase $178 billion over the following 8 weeks once debt limit concerns were resolved. Of note, dealers anticipated market capacity of $210 billion over that same period without causing significant price distortions in the front end of the curve. The Committee discussed at length the speed with which Treasury should replenish the cash balance. The Committee generally agreed that Treasury should increase issuance at a moderate pace, taking into account seasonal factors, potential market impact of rapid Bill issuance, and operational risk of running below the recommended target cash balance for a prolonged period.
Based on current fiscal projections, and in line with the May recommendations, the Committee suggested no change to coupon issue sizes for this quarter, and expected little or no change to nominal issuance for much of FY 2020, based on current forecasts. The Committee agreed that maintaining current coupon sizes was most consistent with Treasury’s regular and predictable issuance strategy to provide lowest cost to the taxpayers over time, but noted that 2021 could require further coupon increases given current fiscal projections despite a likely return to SOMA portfolio growth. The Committee briefly discussed recent cheapening of Treasury securities relative to swaps and agreed levels warranted close monitoring.
The Committee recommended increasing TIPS issuance sizes for Q4 of FY 2019 given the pre-announced change in the auction schedule. Specifically, the Committee recommended increasing the August 30- year reopening by $2bn to $7bn, increasing the September 10- year reopening by $1bn to $12bn, and a new issue size of $17bn for the inaugural new issue 5- year TIPS in October. This issuance strategy would be broadly consistent with TBAC’s prior recommendation that TIPS issuance increase by $20-30bn in 2019, and maintain TIPS share of overall debt. Given the significant but anticipated change in the TIPS issuance pattern this quarter, the Committee encouraged Treasury to continue to closely monitor market demand and liquidity for TIPS.
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 composition changes in the SOMA portfolio.
Primary dealers also commented on the potential costs and benefits of the official sector encouraging broader use of central clearing for Treasury securities as suggested by the recent TMPG white paper on Treasury clearing and settlement risks. On the benefits side, transparency and centralized risk should allow for participants to better understand their exposures, may reduce un-margined credit risk and may minimize market disruptions due to a participant default. On the costs side, centralized clearing would increase concentration risk to a single counterparty and may increase transactions costs. The Committee was supportive of Treasury continuing to study the potential for increased usage of central clearing of Treasuries.
The Committee next reviewed a charge comparing a hypothetical introduction of 1- year SOFR FRN to a 1- year T-Bill FRN, and an increase in 1- year T-Bill issuances. Based on current market data, using both forward rates and GSE issuance as a baseline, the Committee expected Treasury could price SOFR FRNs reasonably in line with or perhaps better than the existing T-Bill FRN pricing. The presenter suggested that demand for a 1- year FRN would be higher than for increased 1- year T-Bill auctions given 2a7 fund WAM considerations. Further, the presenter highlighted benefits of a 1-year SOFR FRN relative to a 1- year T-Bill FRN, notably larger demand for a daily resetting floater and diversification by using an index that is not self-referential. Several areas were recommended for further study in consultation with market participants including technical design of a possible SOFR FRN, ongoing demand for the 2- year FRN, sizing of potential 1- or 2- year issuance, and standardization of indices across FRNs, amongst others.
The Committee again agreed that introduction of a Treasury SOFR FRN would be a significant step forward in boosting the liquidity of the SOFR market and could help expedite the overall market transition away from LIBOR. The Committee unanimously agreed that Treasury should play a prominent role in developing the SOFR market by considering SOFR-linked FRN issuance, particularly if it does not come at an increased cost to taxpayers. The Committee noted that Treasury issuance of a SOFR-linked FRN was unlikely to be imminent given operational issues and design choices.
Respectfully,
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Beth Hammack
Chair, Treasury Borrowing Advisory Committee
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Daniel Dufresne
Vice Chair, Treasury Borrowing Advisory Committee