Mnuchin's Treasury Poised to Rev Up Supply as Budget Gap Widens

(Bloomberg) -- The U.S. government’s need for new financing, rising in part from tax cuts and increased spending under President Donald Trump, has Wall Street predicting the Treasury will ramp up borrowing yet again next week.

Treasury officials are set to announce this quarter’s funding plans on May 2, and bond dealers expect another across-the-board boost to auction sizes, including for inflation-linked debt. The nation’s fiscal overseers may have little choice, with deficits projected to surpass $1 trillion by 2020. The deterioration in federal finances, which is putting the U.S. debt profile on track to resemble Italy’s, is becoming more glaring ahead of crucial midterm elections in November.

American taxpayers are already bearing the cost, as swelling issuance has helped drive yields on some maturities to the highest in a decade. Government debt sales will more than double this year, to a net $1.44 trillion by JPMorgan Chase & Co.’s estimate, raising the specter of buyers’ fatigue just as the Federal Reserve is shrinking its $4.4 trillion balance sheet and raising interest rates.

“The Treasury’s funding needs are massive,” said John Briggs, head of strategy for the Americas at NatWest Markets. “A lot of clients we speak to around the world say they are concerned about how the U.S. is going to fund this deficit. With the supply outlook following the tax changes and new budget, Treasury yields should move upward through the year.”

The debt burden was already ballooning when Trump took office. It doubled under former President Barack Obama amid rising entitlement costs and as the administration stepped up borrowing to counter the recession, and now stands at $14.9 trillion.

The public debt will rise more than $10 trillion by 2028, the nonpartisan Congressional Budget Office estimates. The load will reach an estimated 116.9 percent of the economic output in five years, surpassing the ratio for Italy, the perennial poor man among major industrialized nations, according to the International Monetary Fund.

“At some point, the bond market is going to have enough,” said Brian Riedl, a senior fellow at the Manhattan Institute and former chief economist for Ohio Senator Rob Portman, a Republican. “They’re going to start to demand much higher interest rates and fiscal reforms and then politicians are going to have to take it seriously.”

Mnuchin has said the tax cuts will pay for themselves through brisker economic growth, which will eventually bring about balanced budgets. The Treasury Department didn’t respond to a request for further comment.

The debt overhang, combined with a slide in the dollar, has strategists warning that international appetite for Treasuries may wane. Meanwhile, simmering trade tensions have fueled speculation that China, America’s biggest foreign creditor, could reduce its holdings.

Budget Strain

“We have benefited from cheap money coming from abroad to satisfy our borrowing habits, but that will change,” said Maya MacGuineas, president of the nonpartisan Committee for a Responsible Federal Budget. “The cost of higher interest rates will take a real toll on our already strained budget.”

Ten-year note yields exceeded 3 percent this week for the first time in four years, while two-year yields touched the highest since 2008. The 10-year yielded about 2.97 percent on Friday in New York.

The relative movements in these maturities left the yield curve flatter, meaning the gap narrowed between short- and long-term rates. Analysts say this trend accelerated in the past three months since Treasury said it’ll focus its supply increases on shorter-dated debt of three years or less. It’s also seeking to stabilize the weighted-average maturity.

For the entire year, Treasury will likely boost coupon auction sizes for maturities of five years and less by triple the amount of longer maturities, said Jay Barry, a strategist at JPMorgan.

While most bond dealers predict another increase in note and bond auctions of all maturities, they differ on the breakdown. Here are the highlights:

• TIPS
  • The majority of firms predict larger offerings of Treasury Inflation-Protected Securities, or TIPS, after this class of debt was left unchanged last quarter. Some anticipate a new five-year TIPS sale in October
• Shift in focus
  • Strategists at more than half a dozen firms, including NatWest, Nomura Holdings Inc. and Societe Generale SA, say Treasury will scale back its focus on two- and three-year notes
  • Treasury will lift 2- and 3-year note sales by $1 billion each month, they say, versus last quarter’s $2 billion monthly boost
    • Citigroup Inc. sees a one-time increase of $1 billion for each tenor, holding at that level over the quarter
  • Treasury will again lift by $1 billion the 5-, 7-, 10- and 30-year sales, most say
• Stay the course
  • Barclays Plc, Deutsche Bank AG and Morgan Stanley are among firms saying Treasury will repeat the February pattern, boosting 2- and 3-year auctions by $2 billion per month
  • Longer tenors will again rise by $1 billion
• Floating-rate notes
  • The majority of firms predict these auctions will rise by $1 billion to $2 billion

Whatever Treasury announces regarding notes and bonds, dealers still expect bills to account for a large share of the 2018 funding increase.

Net bill issuance this year will increase by a range of $500 billion to $550 billion, according to Margaret Kerins, head of fixed-income strategy at BMO Capital Markets Corp. At about 15 percent, bills’ share of total debt is the highest since 2013.

No matter the mix, there’s little dispute the debt burden is set to climb. Treasury will announce its estimated borrowing needs for the current quarter on April 30.

The Treasury signaled this month that it’s pondering issuance plans for years to come. Officials asked dealers in their pre-refunding survey for borrowing forecasts for the coming three fiscal years, in addition to the outlook for foreign demand and TIPS.

“We are flirting with about $15 trillion in debt and this will grow by well over a trillion every year for the foreseeable future,” said Michael Cloherty, head of U.S. interest rate strategy at RBC Capital Markets. “We’ll start to get a crowding-out effect with this and upward pressure on yields.”

To contact the reporters on this story: Liz Capo McCormick in New York at emccormick7@bloomberg.net, Saleha Mohsin in Washington at smohsin2@bloomberg.net.

To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Alex Wayne at awayne3@bloomberg.net, Brendan Murray at brmurray@bloomberg.net, Mark Tannenbaum, Sarah McGregor

©2018 Bloomberg L.P.