Bond investors are beginning to absorb a mushrooming supply of Treasury securities issued to pay for the new coronavirus stimulus plan, but how seamlessly the new debt is digested may depend on whether it is short or longer-term.
President Donald Trump last Friday signed into law a $2.2 trillion aid package, the largest ever, that includes sending checks to Americans with lower incomes, expanding unemployment benefits and rushing billions of dollars to medical providers on the front lines of the pandemic.
The Treasury has ramped up sales of short-term Treasury bills to finance this spending, and this is expected to continue. Longer-term, auctions sizes across the Treasury curve will need to increase, while the government is also expected to turn to new products and maturities to help increase demand for its debt.
“I think there are a lot of changes coming to the issuance calendar,” said Gennadiy Goldberg, an interest rate strategist at TD Securities in New York.
The surge in issuance could provide some relief to short-term debt investors after bill yields turned negative, but risks sending yields on longer-dated debt higher and steepening the yield curve.
“On the front-end it’s actually going to be a positive because bill rates have been trading negative and the more supply you get, the more that’s going to bring it back into positive territory,” said Subadra Rajappa, head of U.S. interest rate strategy at Societe Generale in New York.
Rajappa said that for longer-dated debt, “my concern is more, once we get past the near-term, how the market’s going to react to this glut of supply, and if there is going to be a snap back to higher yields in a short period of time.”
Higher long-term rates can burden the economy by making it more expensive for the government, companies and consumers to borrow.
Analysts at Wells Fargo on Tuesday forecast that net Treasury debt is likely to jump by $1.4 trillion in the second quarter, and by $2.8 trillion this year.
MOVING OUT THE CURVE
The government is expected to concentrate the bulk of its issuance in shorter-term paper, which should draw strong demand as long as the high demand for low-risk assets persists.
The Treasury Department has announced $330 billion in cash management bills in the past week - short-term securities issued to help it manage its immediate funding needs, sold in addition to regularly scheduled bill sales.
That could help ease stresses for money market fund managers that invest only in government debt, who have started to turn away new investments as demand for low-risk assets has surged and short-term Treasury bills turned negative.
Negative yields mean that an investor pays the government to hold the debt, making it difficult to cover fund expenses and generate returns.
Assets in money funds that invest only in U.S. government debt jumped to $3.50 trillion in the week ending March 31, from $2.65 trillion on Feb. 25, according to data by iMoneyNet.
The government will also need to increase the size of its longer-dated debt auctions over time. These increases are likely to be announced at the quarterly refunding on May 6, though they could come sooner.
On Thursday the Treasury modestly increased the size of next week’s coupon auctions, adding $2 billion to its three-year sale and $1 billion each to its 10-year and 30-year auctions, compared with last month.
In addition to increases in auction sizes, analysts expect a number of new products to be launched, with new 4-year notes, 20-year bonds and floating-rate notes linked to the Secured Overnight Financing Rate (SOFR) among the most likely.
Federal Reserve bond purchases may be key to how well increases in longer-dated debt are absorbed by the markets.
The Fed has increased the size of its purchases in the past month in an effort to ease stresses in the Treasury market, which suffered from broad liquidity problems as investors rushed to sell assets across the board and raise cash.
The Fed’s bond holdings jumped to a record $5.25 trillion on March 25, from $4.16 trillion on Feb. 26.
However, the Fed may not keep buying at that pace if market functioning returns to normal. This could be particularly so if the economy bounces back quickly once the virus is brought under control.
“If markets stabilize, they’re probably not going to continue to buy securities,” said Tom di Galoma, managing director at Seaport Global Holdings in New York. “I think it’s going to cause some temporary log-jams, no doubt. You’ll be caught between increased supply and the Fed buying securities.”
Some of the probability of higher long-dated yields may already be priced into the Treasury yield curve, which has steepened since the beginning of March. The spread between two-year and 10-year notes is now 38 basis points, up from a low of 2 basis points reached on March 9, though below the two-year high of 77 basis points hit on March 18.
“There will be pockets where it won’t get absorbed, but mostly it will. That is why we have a positively-sloped yield curve despite how bad things are,” said Andrew Richman, managing director of fixed income at Truist/SunTrust Advisory Services.