Knock on wood I suppose, but the US bond market’s reaction to Treasury’s closely-watched refunding announcement looked pretty tame, all things considered.
By “all things considered,” I’m referring not only to the fact that the borrower was downgraded 15 hours prior to the unveil, but also to generalized investor concerns around supply at a time when interest costs are rising and the Fed is still letting its balance sheet roll off.
Fitch cited projections for the US government’s debt servicing costs in Tuesday’s downgrade rationale. I won’t subject readers to a lengthy, philosophical diatribe, but I will reiterate what should be obvious to everyone. “Cost” is a misnomer, and so is “debt.” Treasurys are just interest-bearing dollars, and the interest is payable in dollars. The US issues dollars at will. The same dynamics apply to all monetary sovereigns, but none of them issue the world’s reserve currency. So, when Fitch says, for example, that “higher interest rates and the rising debt stock will increase the interest service burden,” and the context is the US Treasury, there’s a sense in which they’re trafficking in gibberish.
I won’t dwell on that point. Some readers aren’t capable of handling the truth when it comes to the US, debt and deficits, and unlike Stephanie Kelton, I don’t have the patience to explain it over and over again to people who refuse to understand. Plus, irritating other human beings ceased to be a source of entertainment and joy for me a long time ago, so I’ll pretend this isn’t all self-referential. (And I’ll leave the terminal users among you to enjoy wading through Cameron Crise’s comically belabored effort to pen the definitive assessment of America’s “deteriorating” deficit, which he ludicrously suggested is “an under-appreciated phenomenon.” Been inside the Beltway recently, Cameron? The deficit isn’t exactly “under-appreciated,” certainly not for its utility as a political cudgel.)
The refunding announcement, which marked the first time coupon auction sizes have increased since 2020, found issuance surprising to the upside (versus expectations) on a few maturities (2s, 5s and 10s). Despite the coupon increases, bills’ share of outstanding debt will probably exceed the recommended 20% threshold. The TBAC minutes suggested dealers are fine with that “given the evolution of the outlook on financing needs, including the rebuild of the TGA, and the alternative of rapid meaningful coupon increases.”
Bills, TBAC said, “have proven to be an effective absorber of unexpected issuance needs,” and “current levels of demand” suggest the “longer-term historical” share of 22.4% should be ok “for some time.” Running bills above the recommended 15-20% range will help “maintain a regular and predictable approach to increasing coupon issuance.”
Obviously, bill supply is a hot topic. Following the debt ceiling resolution, Treasury opened the floodgates. So far, RRP transformation (which is to say money market funds rotating out of the Fed’s repo facility and into bills) has been sufficiently large to rule out worst-case reserve drain scenarios, thereby allaying a number of related concerns around prospective reserve scarcity.
Money market funds, TBAC said, “still hav[e] significant room to absorb additional T-bill supply,” and if macro conditions evolve in such a way as to reduce the odds of additional Fed hikes, that should further boost demand from money funds, who’ll then be more comfortable with maturity extension and won’t have to worry about foregoing incremental yield pickup from higher RRP rates.
“Treasury’s $800 billion increase in bill supply since the debt ceiling suspension has already pressured bills wider [and] with more to [come] we expect bills to cheapen relative to OIS,” TD’s Gennadiy Goldberg said Wednesday, adding that dealers’ bill inventories “have already reached record high levels, which should continue to put pressure on the sector even as RRP usage has continued to slip.”
The refunding announcement went on to note that although “gradual” coupon auction increases “will make substantial progress towards aligning auction sizes with intermediate- to long-term borrowing needs,” additional increases will likely be necessary. The scope of any such increases depends on America’s fiscal trajectory and what happens with QT.
I suppose you could argue, as some traders apparently did Wednesday, that all of this points to structurally higher US yields (i.e., yields that are higher than they would’ve been net of macro-driven oscillations and monetary policy considerations). I wouldn’t necessarily disagree, but in the final analysis, there will be sufficient demand for US bonds, bills, promissory notes, hand-written IOUs and any other instrument Treasury wants to issue, because there isn’t a viable alternative.
As I put it a few days ago in “Chasing US Exceptionalism,” (an article which now seems quite prescient in light of Trump’s indictment and the Fitch downgrade), “worsening political gridlock and, more recently, the deterioration of democratic norms, have steadily eroded America’s international image and undercut the country’s claim to being a ‘shining city on a hill,’ but the appeal of US dollar assets remains.”
Coming full circle, the muted reaction in bonds Wednesday to the one-two punch of Fitch’s downgrade and the refunding announcement, speaks to that latter point.
Something I’ve come to appreciate recently is the large increase in interest payments over the last year. I know there are a bunch financial tightening processes going on, but for people with savings, there is a pretty big raise. I know this not spread to the people most likely to spend it, but it is money injected into the economy and a lot of it would seem.
Whether the Federal debt is or is not really “debt” is not, I think, the end of the story.
Everyone – government, politicians, investors – treats it as debt. That means when old “debt” matures and revenues undershoot spending, new “debt” has to be issued and sold at the yield that investors demand.
If it wasn’t treated as debt, the Treasury wouldn’t have an account at the Fed that runs low and needs replenishing; Treasury would simply be the Fed and type extra trillions into its TGA as needed without all the tiresome auctioning.
Sure, until Rome falls there will be demand for Treasuries. Demand will grow, more or less, depending on the growth of the global economy, wealth, trade, investment, etc. Supply (issuance) also grows, more or less, depending on tax revenues, spending, maturities, etc.
The shock absorber between demand growth and supply growth is yield. Yield drives duration asset valuations. Stocks and bonds are duration assets.
So it seems to me that investors do have a reason to prefer lower deficits and restraints on issuance (within reason).
You’re missing the Fed, the money printer, as a major purchaser. Thanks to them we had extremely low interest rates even though the debt trajectory was similar to today’s.
If for some reason interest rates get too high because debt buyers are scared of deficits, the Fed would step in to control rates.
This is the point H keeps making: when it comes to the US, the concept of national debt should really be seen as measure of money in circulation and not something the US inhabitants will need to repay via tax increases. It’s only a problem when the money printed is not used to grow the economy/productivity.
I lost whatever rubber stamp faith I had in credit agencies (Fitch too!) after the Great Financial Crisis. I’d dare wonder what private conversations occurred in Fitch that made them “this time” feel like the US has financial instability since it’s all relative: Russia, China, or even the UK don’t seem AAA places to me?
Pretty easy money to finally get 5% from the US govt, how many other bond issuers (or even VCs themselves) are now in a bind to outperform?
Or more accurately what money influenced their credit rating decision since that is essentially their business model. Payment for ratings.