(Bloomberg) — Investors who invested in government bonds and have had to grapple with a series of issuances over the last year are now bracing for the opposite challenge: a drop in sales that will leave them flooded with cash to be deployed elsewhere must.
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The government is expected to announce further cuts to government bond issuance for the May-July period on Wednesday. Bank of America Corp. expects a $401 billion decline in the net supply of Treasury bills in the second quarter. Wells Fargo & Co. expects a $321 billion reduction, while Goldman Sachs Group Inc. expects $250 billion fewer bills.
Traders worry that the dwindling supply of banknotes available could fall far short of demand and throw money markets into turmoil. It’s a mismatch that led investors to park trillions of dollars in a key Federal Reserve facility two years ago. This time there is a risk that the central bank will be blocked from ending its balance sheet squeeze.
“We think there will be an acute imbalance between supply and demand initially, with demand outstripping supply,” said Mark Cabana, head of U.S. interest rate strategy at Bank of America. “It’s overwhelming because it begs the question, ‘Who’s going to buy all the Treasury securities?’ turns on its head. Logic turned on its head.”
Drain supply
The reduction in T-Bill supply in the US began at the beginning of the year. After selling a flurry of securities in the second half of 2023 after resolving the debt ceiling debate, the government scaled back its issuance plans in anticipation of a heavy tax burden.
Negative net sales this month alone were $196 billion, compared with the Treasury Department’s forecast that bill sales would fall by $100 billion to $150 billion in April. The Treasury does not provide detailed bond issuance plans to make up for gaps created by coupon supply.
Higher tax revenues from a booming economy and reduced borrowing due to a smaller deficit are among the reasons cited by banks predicting a further decline in note issuance. While second-quarter government debt estimates released Monday were $41 billion higher than U.S. debt managers said in January, the Treasury estimate did not take into account the widely expected slowdown in the Fed’s reduction of Treasury holdings.
Tom Simons, a senior economist at Jefferies, forecast a $269 billion decline in T-bill issuance for the current quarter, adjusted for the latest borrowing estimate. Bank of America’s Cabana kept his forecast unchanged, but noted that the government’s higher borrowing estimate posed a risk to the view that bill payments will be as high as predicted.
“This is something worth watching,” said Subadra Rajappa, head of U.S. interest rate strategy at Société Générale SA, which reported a $220 billion decline in bill sales for the current quarter following the latest borrowing revision. Dollar forecast. “Especially at a time when there is significant investor demand for front-end products.”
Money market funds – which typically hold T-bills among other short-term securities – have risen to a record $6.1 trillion this month as a stronger economy and persistent inflation prompt Fed officials and the market to to curb expectations of interest rate cuts this year. increase their attractiveness.
Demand for government bonds from these funds is also expected to increase. An upcoming rule change will create an incentive to shift capital into a particular type of money market fund that buys almost exclusively government bonds, rather than those that also invest in riskier assets like commercial paper.
QT Curveball
So where will all the money go? Historically, a shortage of short-term assets has resulted in money being sent to the Fed.
Use of the Fed’s Reverse Repurchase Agreement Facility – a barometer of excess liquidity for funding markets known as RRP – topped $2 trillion in mid-2022, as the pandemic’s massive stimulus and quantitative easing measures hit the US dollar Fed-generated funds were looking for a home.
Funds parked in that facility remained at about that level until last year’s flood of T-bill issuance caused most – about $1.75 trillion – to exit between June and April.
This decline in excess liquidity has focused attention on how much the Fed can shrink its balance sheet – a process known as quantitative tightening – before funding markets begin to crack. Chairman Jerome Powell said in March that the Fed would begin cutting QT “fairly soon”; Traders await further details from Wednesday’s Fed meeting as to when it will begin.
If thwarted T-Bill investors stash their cash in the RRP, it could cloud the conditions for ending the QT program as the central bank does not have a clear view of liquidity. The Fed has said it is keeping an eye on the RRP to determine whether the market has sufficient liquidity.
“In terms of the Fed’s QT, you can argue with that logic that given this imbalance between supply and demand, maybe they should continue the QT for longer,” Bank of America’s Cabana said.
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