Banded dollar notes are handled while traveling through a large examining packaging equipment machine at the U.S. Bureau of Engraving and Printing in Washington, D.C. (Photographer: Andrew Harrer/Bloomberg) 

Treasury Supply Shock Has Yet to Fully Hit the Market: Analysts

(Bloomberg) -- The U.S. Treasury is confident there will be strong demand to absorb the deluge of supply of debt that is yet to come after boosting issuance for the second quarter in a row. Wall Street warns this will happen at increasingly higher costs.

While Treasury yields barely budged on the announcement, some analysts said the worst is yet to come, with annual borrowing needs expected to soar above $1 trillion by 2020 amid tax reductions and higher fiscal spending.

“Increased issuance sizes have been anticipated and expected in the market,” said Deputy Assistant Treasury Secretary Clay Berry at a press conference Wednesday. “I don’t think we have any concerns at this time with demand meeting any increases in supply.”

Indeed, bond traders took in stride the Treasury Department’s plans to lift long-term debt sales to $73 billion this quarter, with the bulk of issuance increases concentrated in shorter maturities. Bank of America analysts said the market is underestimating the cumulative supply shock that’s coming for global rates and expect the combined effect of the Fed’s balance sheet unwinding and a potential decrease in foreign purchasing to push the 10-year Treasury yield to 3.25 percent by year end.

“This is a secular shift that likely requires higher rates to entice investors to absorb the difference,” analysts led by Ralf Preusser wrote.

Here’s what analysts say about the Treasury’s supply plans:

Sit Investment Associates (Bryce Doty, interview):

  • The U.S. Treasury’s financing plans for May-July quarter show continued over-reliance on the bill sector, “the auction schedule for bills is not sustainable”
  • 10-year yield driven above 3% by inflation concerns, “but this quarter might be the last time the market’s able to absorb the additional supply of bonds well” with yields set to rise due to supply-demand dynamics

TD Securities (Priya Misra and Gennadiy Goldberg, note)

  • Recent bull flattening of the Treasury curve “suggests structural demand in the long end which could persist for a while”
  • “For now, pension demand in the long end seems to be dwarfing the duration supply”

Stone McCarthy Research Associates (note):

  • “Market participants may experience some sticker shock once the Treasury starts to more aggressively expand auction sizes”
  • “The Treasury market is also vulnerable to demand-side shock,” with the greatest threat being an abrupt decrease in foreign purchasing
  • Expects Fed unwinding of Treasury holdings to pressure interest rates upward

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