Cresting Flood of U.S. Treasury Supply May End Auction Woes

The rising tide of U.S. Treasury sales may be cresting -- and not a moment too soon.

Steep increases in the size of U.S. government bond auctions over the past year are showing signs of making it difficult to drum up demand.

February’s auction of seven-year debt produced a record low number of bids for the amount being sold. That showed the pool of buyers was taxed after sales of the maturity swelled by $3 billion a month since April 2020 to $62 billion by January. Last month’s auction wasn’t that much better. And 20-year bond offerings have struggled, too, since they returned in May.

But the size of such auctions are poised to start declining later this year, some Wall Street strategists predict, ending a torrid pace of increases as the federal government spent heavily to soften the hit of the pandemic. It would be the first such slowdown since 2016, potentially easing the pressure on a market where yields surged during the first three months of the year on speculation that the economic rebound and federal spending increases will cause inflation to accelerate.

“Smaller auctions would be easier to digest” and allow for increased sales of scarce Treasury bills, Jefferies economist Thomas Simons said. At the same time, “the signal that we’ve hit the top in supply would help to tighten up the auctions even before the cuts come.”

Such a pullback would reflect the steep rebound in economic growth after federal stimulus efforts and the steady roll out of the Covid-19 vaccines. As a result, if the pace of borrowing remains the same, the federal government is likely to have far more cash than it needs even as it continues to contend with budget shortfalls.

No such plans have been announced by the Treasury Department and the timing of any cutback is far from certain. Moreover, the passage of President Joe Biden’s infrastructure plan could influence how much needs to be borrowed, as could the potential reinstatement of the federal debt ceiling at the end of July. That’s left some analysts skeptical the cuts will come as soon as this year.

“Throughout the pandemic Treasury has been conservative -- that is, they raised more debt quickly and maintained a higher cash balance,” said Zachary Griffiths, a rates strategist at Wells Fargo & Co. “We expect them to maintain that mantra going forward as there is still plenty of uncertainty in the outlook.”

Even so, analysts project that the size of the debt offerings will almost certainly be pared back eventually. Barclays Plc interest-rate strategists Anshul Pradhan and Andres Mok estimate that if no changes are made to the Treasury’s auction sizes the government would raise $400 billion more than it needs in the current fiscal year and more than $1 trillion more in each of the following two years.

If the auctions aren’t cut “it would be significantly over-funded next year and the year after,” the Barclays strategists wrote in an April 8 report. The bank projects a drop of 10% to 20% in Treasury issue sizes over six months, a trend that would reduce quarterly sales of 10-year notes from $117 billion in the May-July quarter to $105 billion in November 2021-January 2022.

Barclays projections for Treasury auction sizes, in $billions
May-July 2021November 2021-January 2022

The step would be a welcome shift to investors, with the market already showing some early signs of testing the Treasury’s long-running ability to ramp up borrowing with impunity. The 20-year bond outperformed on Friday after the Treasury’s quarter dealer survey asked whether changes to its size should be considered, showing how tweaks may affect the market dynamics.

While most auctions have continued to go smoothly and yields remain low by historical standards, there have been some signals that demand is being taxed.

The seven-year auction on Feb. 25, for example, drew a yield more than four basis points higher than dealers expected as the bid-to-cover ratio hit a record low. Those results deepened the market’s biggest daily selloff since March 2020, driving the benchmark 10-year yield up more than 14 basis points that day to more than 1.5% for the first time in nearly a year. It’s now around 1.6%.

“The amount of duration dealers are absorbing at auction each month has doubled over the past year, while risk-taking capacity remains constrained,” JPMorgan Chase & Co. strategists wrote last month.

TD Securities also predicts auction-size cuts starting in November if tax increases offset the cost of government spending. In any case, head of U.S. rates strategy Priya Misra said, the Treasury has ample capacity to increase sales of short-term bills -- instead of longer-term bonds -- to fund new spending.

Cutting auction sizes also would blunt the impact if improving economic conditions cause the Fed to reduce its purchases of Treasury securities from the current $80-billion-a-month pace.

©2021 Bloomberg L.P.

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