This week’s Treasury financing estimate and refunding announcement are a big deal.

Indeed, as discussed briefly here, there’s a strong argument to be made that the refunding announcement is more important than the October jobs report, or at least for the bond market.

The narrative is simple: The most acute Treasury selloff in a generation (which threatens to make 2023 the third consecutive year of US government bond losses, a first in the history of the republic) is in no small part attributable to supply concerns in an environment where the buyer base for US debt is undergoing a structural shift.

No longer can the US depend on a price-insensitive bid (e.g., from the Fed, which is boxed in by the inflation fight). Price discovery is back, and at an inopportune time.

America needs to finance growing deficits and the appearance of almost existential political dysfunction inside the Beltway suggests the odds of bipartisan fiscal reform are long indeed. As such, the term premium is back, long-end yields are rising and the combination of higher debt and higher costs to service it is cause for consternation. That consternation manifests in an even higher term premium and on and on.

With that in mind, I wanted to highlight a few brief excerpts from analyst/strategist commentary around the refunding announcement. If nothing else, it gives you a sense of the numbers and the key issues.

Continued coupon size increases, with a lean towards bills: [This week] Treasury will announce its expectation for Q4 privately-held marketable borrowing, which it had estimated to be $852 billion at the last refunding meeting. That number is higher than our forecast $739 billion for Q4. The difference partly reflects our assumption on TGA — we forecast a ~$710 billion end-of-year balance versus Treasury’s $750 billion — but likely also stems from different quarterly budget deficit estimates. Of our $739 billion borrowing estimate, we expect $338 billion and $402 billion to come from net coupon and bill issuance, respectively.

In terms of duration supply, our forecasts imply a $206 billion issuance in 10-year equivalent terms over 4Q24, roughly 7% above the previous quarter and 14% above Q2.

We had flagged that Treasury would continue to increase coupon auction sizes this cycle and would be unlikely to aggressively tilt the maturity distribution of new issuance towards bills. That said, our forecasts already feature a moderately slower pace of size increases for the current cycle compared to the prior cycle, which in turn means a heavier lean towards funding via bill issuance versus consensus. We believe that slowing in the pace of coupon auction size increases, were it to occur, would be more likely at long maturities and could result in the yield curve flattening following such an announcement. If Treasury continues to increase coupons at its previous pace, however, we could see the curve trade with a mild steepening bias in the aftermath.

— Praveen Korapaty and George Cole, Goldman

Aside from the issue-specific questions, the Treasury Department also asked how much larger the bill market could become before risking valuation distortions — a notion that resonates with the reintroduction of term premium in the long-end. Additionally, even as coupon auction performance has been lackluster, bills have seen generally solid primary market sponsorship even as the overall level of bills outstanding has reached $5.3 trillion. That should leave the stewards of the deficit comfortable with what we’re expecting will be net bill issuance on the order of $500 billion for the quarter and continuing to push bills as a share of overall marketable debt outstanding higher.

— Ian Lyngen and Ben Jeffery, BMO

The dominant focus at the upcoming Treasury refunding will be on financing needs. While we continue to believe that the main driver of the recent rise in rates has been the repricing of Fed expectations, the ongoing increase in Treasury supply and worries about a lack of demand are keeping investors on edge. A number of factors continue to push deficit projections higher:

1. Growth slowing and rising outlays: Moderating growth momentum has pushed revenues lower as a portion of GDP while outlays have continued to increase. We view these dynamics as unlikely to change any time soon, especially given our expectation for growth to slow and a recession to begin in Q2 2024.
2. Higher funding costs: With a 6.2-year average maturity, the increase in Treasury’s funding costs should be gradual. However, the recent deluge of bill supply helped accelerate the rise in funding costs. The interest rate paid on the debt by Treasury has already jumped from 2.4% of GDP in early-2022 to 3.3% in September 2023. This cost is likely to continue rising in the coming months, with interest outlays jumping to $850 billion over the past 12 months from $600 billion in early-2022.
3. 2024 presidential election: The rapidly approaching election next year will leave politicians with little incentive to rein in government spending. While we expect fiscal standoffs to persist as the government remains funded only through November 17, any savings stemming from an agreement to end the shutdown are likely to be modest at best.

The FY2023 deficit increased much more sharply than anticipated to $1.7 trillion amid higher spending and softer receipts. We expect deficits to continue rising in the coming years, increasing to $1.85 trillion in FY2024 and $1.9 trillion in FY2025. In addition, we see deficit risks tilted to the upside due to several key factors:

1. Ukraine/Israel financing: President Biden proposed $106 billion in supplementary financing for Ukraine and Israel, which would continue to increase deficits in the near-term.
2. Fed balance sheet runoff: A major source of financing needs is the Fed’s quantitative tightening (QT) program. The Fed is currently allowing up to $60 billion of Treasurys to mature from their balance sheet each month. This effectively increases Treasury’s financing needs by $720 billion per year since Treasury must raise funds in private markets and repay the Fed. We expect the Fed to discontinue QT as soon as rate cuts begin in June 2024, but a later end to QT could further increase Treasury’s funding needs.
3. Ongoing rise in mandatory outlays: One trend that has accelerated sharply is the increase in mandatory outlays in recent years. Discretionary outlays have declined to just 14.5% of overall spending compared with 19% in 2010. This trend makes it more difficult for Congress to cut spending to bring down deficits and rising interest costs will further decrease the share of the discretionary budget.

— Gennadiy Goldberg, Molly McGown, TD Securities

Bonds still can’t hold a squeeze, as there simply aren’t enough buyers of duration until the data dumps versus current supply realities and QT impacts into perpetually higher fiscal deficit spending. That said, and as I highlighted whispers of such a scenario a few times in recent weeks, the murmurs are getting louder with regard to the potential that the upcoming Treasury refunding announcement could surprise current market assumptions of the distribution of issuance, with more Bills (“strike while the iron is hot” into enormous demand  from MMFs) and less coupon, all in a Treasury rethink to mitigate potentially negative impacts of the violent move higher in the term premium in recent months, which we all know Janet Yellen is very much aware of. That said, if this Treasury ‘refunding twist’ does NOT occur, and with all the structural headwinds remaining in the background on top of Nominal GDP with a +7%-handle, it would be extremely difficult to envision rates / USTs rallying into year-end — again, until the data dumps.

— Charlie McElligott, Nomura