Welcome to the New Reality of Leaping U.S. Treasury Debt Sales

(Bloomberg) -- The world’s biggest bond market is about to get a taste of the future, with the U.S. Treasury expected to unveil bigger note sales for the first time since 2009 to fund budget deficits that are likely to deteriorate for years to come.

Treasury Secretary Steven Mnuchin’s debt-management squad is scheduled to announce on Jan. 31 how it plans to finance the government’s shortfall over the next three months, and Wall Street prognosticators anticipate bigger auctions of coupon-bearing securities. Dealers forecast an onslaught of debt supply that will lead issuance to at least double this year to more than $1 trillion, the most since 2010, starting with sales of short- to medium-term maturities.

The catch is that buyers may struggle to keep up: Central banks are showing signs of stepping back, and other investors may want to see higher yields before pouncing. That backdrop also contributes to forecasts for a flatter yield curve in 2018, given expectations that the Federal Reserve will hike rates further as inflation picks up.

“There will always be demand, but the question is just at what price,” said Torsten Slok, chief international economist at Deutsche Bank AG. “It’s fair to say the reason why the consensus is for Treasury yields to move higher is because of this growth in supply.”

The latest projections from analysts show where that clearing price may be. Forecasters see 10-year yields reaching 2.9 percent by year-end, from about 2.61 percent now. Yields have already climbed more than a half-percentage point since early September, to the highest since 2014.

America was already on course to go deeper into the red to pay for rising Social Security and Medicare expenses and mounting interest costs on its debt. That trend got added fuel from the tax overhaul passed last month. Treasury also faces more borrowing as the Fed steps up its balance-sheet runoff.

‘Unmistakable’ Path

While President Donald Trump’s administration says the tax bill will stimulate enough economic growth to cover lost revenue, Congress’s tax scorekeeper estimates the changes will raise deficits by more than $1 trillion over the next decade.

“We were on an unmistakable upward trajectory to begin with,” and the tax laws compounded it, said Douglas Holtz-Eakin, president of American Action Forum in Washington and former chief economist to the Council of Economic Advisers under George W. Bush.

The U.S. posted its largest budget deficit since 2013 in the fiscal year that ended in September. Even before the tax rewrite, the Congressional Budget Office forecast that the public debt would increase by more than $10 trillion by 2027.

JPMorgan Chase & Co. strategists this month lifted their forecast for net new Treasury issuance in 2018 by about $100 billion, to around $1.42 trillion, after the passage of the tax bill. Net sales in 2017 totaled about $550 billion.

Treasury’s Signal

“Supply is going to be a factor to watch and monitor very closely,” said Dan Heckman, a Kansas City-based fixed-income strategist at U.S. Bank Wealth Management, which oversees $151 billion. He expects 10-year yields to reach from 2.75 percent to 3 percent in December.

“There are so many different forces going on now” that will cause a “gradual climb in rates,” he said.

The Treasury said in November that it anticipated increasing coupon auctions this quarter. It would be the first boost to note or bond sales since November 2009. The Jan. 31 announcement will include specifics on the following week’s offerings of 3-, 10- and 30-year maturities. But dealers also expect guidance on other tenors, with details to be unveiled in February.

A big chunk of the new supply is expected to come through bills, as soon as lawmakers hoist or suspend the debt limit again. New bill issuance could tally $300 billion to $600 billion in the coming year, judging by analysts’ predictions. The remainder of the increase would come through coupon auctions.

Flattening Fuel

Many dealers expect Treasury to start increasing offerings in maturities up to five years, before moving to longer tenors. That could magnify a dominant trend in the bond market, the shrinking spread between short- and long-term yields that’s flattened the curve to levels last seen a decade ago.

Jefferies LLC and Societe Generale SA forecast 2-, 3- and 5-year auction increases over the quarter. TD Securities sees more 3-, 10-, 30-year debt and floating-rate notes. Morgan Stanley predicts Treasury will lift various maturities quarterly in 2018.

In November, the most recent quarterly refunding, the government announced sales that month of $24 billion of 3-year debt, $23 billion of 10-year notes and $15 billion of 30-year bonds. The Treasury sells additional amounts of these securities in other months. It plans to sell $26 billion of 2-year debt, $34 billion of 5-year and $28 billion of 7-year notes this week.

Below is a quarterly snapshot of how SocGen sees nominal coupon auction sizes evolving:

Maturity2-year3-year5-year7-year10-year30-year
February$28b$26b$35b$28b$23b$15b
May$32b$28b$38b$29b$24b$16b
August$34b$30b$40b$32b$25b$16b
November$34b$30b$40b$34b$26b$16b

The deluge, combined with the potential of diminished central-bank purchases just as multinational companies may lighten up as well, spells trouble, said Jason Brady, president of Thornburg Investment Management.

“You have all these things pointing in the same direction,” said Brady, whose firm in Santa Fe, New Mexico, oversees $52 billion. For bond investors, “this environment is just not great.”

©2018 Bloomberg L.P.

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