US bond market braces for surge in Treasury supply in second half

Reuters

6 hours ago

BOSTON, June 24 (Reuters) - The bond market is bracing for up to $1 trillion of additional U.S. Treasuries supply in the second half of the year once lawmakers address the looming debt ceiling problem, possibly permanently, top rates strategists said on Tuesday.
Any new issuance will likely be focused on shorter-dated debt including bills.
With the flood of Treasuries, market participants are left to wonder: who is going to buy them all? Treasury issuance is meant to address the U.S. government's huge fiscal deficit.
President Donald Trump's sweeping tax-cut and spending bill would lead to a larger-than-expected $2.8 trillion increase in the federal deficit over the decade, despite a boost to U.S. economic output, the nonpartisan Congressional Budget Office projected.
The U.S. Senate could vote on Friday on Republicans' tax and spending measure, said Treasury Secretary Scott Bessent on Tuesday, and he was confident the House would then pass that version.
"We are just about to go through a level shift," said Mark Cabana, head of U.S. rates strategy at BoFA Securities, during a panel discussion on Tuesday at the Money Fund Symposium in Boston. "You're going to see this big issuance clip and it's coming within the next few months. You can debate exactly when they raise the debt limit, but the X-date is coming soon."
Bessent had said that the so-called X-date when the government would exhaust remaining borrowing capacity under the federal debt ceiling would come sometime during the mid-to-late summer. When the debt ceiling is reached the Treasury is unable to increase borrowings, but if it is lifted or eliminated, the government can then issue more debt.
Cabana's forecast is for new supply of Treasuries to hit $1 trillion by the end of the year. Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, also expects an increase of nearly $1 trillion in issuance this year, with about $700 billion supply in August and September.
A surge in Treasury supply could increase repurchase, or repo rates, which refer to the cost of borrowing short-term cash using Treasuries or other debt securities as collateral. Higher Treasury supply typically saturates the market with additional collateral, which can initially lower repo rates due to excess supply. However, if supply exceeds demand substantially, it may lead to higher repo rates as lenders demand more compensation for holding larger volumes of securities.
Goldberg thinks this year's supply will be concentrated on the front end of the Treasury curve - the two-year to the seven-year sector.
"Our expectation is that the Treasury keeps issuance focused on the very front end of the curve in terms of coupons. We're not expecting auction size increases until the middle to end of next year, so August or November of 2026, and we don't expect any increases in the long end either," Goldberg said.
"In fact, I wouldn't be surprised if there are some decreases in size on the long end, but twos, threes, fives, sevens, that's where the Treasury is going to really look to finance themselves, not 10s, not 20s, not 30s. So it's really that and bills."
Adding to Goldberg's point, Ian Lyngen, head of U.S. rates strategy at BMO Capital Markets. noted that the U.S. Treasury has become so market-sensitive that it is willing to pull back on longer-term issuance if it leads to volatility in yields.
It is not just the Treasury Department that has been more cognizant of the market's reaction, he said, but also Japan's Ministry of Finance and the UK.
Money market funds, whose assets hit a record $7.4 trillion in June, are well positioned to absorb part of that Treasury supply, the strategists said. However, there has been a modest shift recently away from Treasuries by these money funds and into private repo transactions because of the latter's higher rates.