(Bloomberg) - Treasury-bill investors that tussled with a swathe of issuance over the last year are now preparing to confront the opposite challenge: A pullback in sales that leaves them awash with cash that needs to be put to work elsewhere.
The government is expected to indicate further cuts to T-bill issuance for the May to July period on Wednesday. Bank of America Corp. expects $401 billion less net T-bill supply for the second quarter. Wells Fargo & Co. sees a $321 billion reduction, while Goldman Sachs Group Inc. is looking for $250 billion fewer bills.
Traders are wary that the dwindling amount of notes available could fall far short of demand, roiling money markets. It’s a mismatch that two years ago drove investors to park trillions of dollars in a key Federal Reserve facility. This time around it risks muddying the path for the central bank to end its balance-sheet tightening.
“We think there is a real risk of an acute supply-and-demand imbalance at the front-end, where demand will outstrip supply,” said Mark Cabana, head of US rates strategy at Bank of America. “It’s mind-blowing because it flips all the ‘Who is going to buy all the Treasury supply?’ logic on its head.”
Draining Supply
The US’s reduction in T-bill supply began earlier this year. After selling a torrent of securities in the back half of 2023 following the resolution of the debt-ceiling debate, the government dialed back its issuance plans in anticipation of a strong tax haul.
Negative net issuance reached $196 billion this month alone, compared with Treasury’s forecast of $100 billion to $150 billion in reductions of bill sales for April. Treasury does not lay out precise issuance plans for bills to allow it to adjust for gaps left by coupon supply.
Higher tax receipts from a booming economy as well as lower borrowing from a reduced deficit are among reasons cited by banks forecasting further reductions in bill issuance. While government borrowing estimates published Monday came in $41 billion higher for the second quarter than US debt managers indicated in January, the Treasury’s estimate didn’t incorporate a widely expected slowdown in the Fed’s run-off in Treasury holdings.
Tom Simons, a senior economist with Jefferies, predicted a $269 billion reduction 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 the government’s higher borrowing estimate posed a risk to the view that bill paydowns will be as large as predicted.
“It’s something worth watching,” said Subadra Rajappa, head of US rates strategy at Societe Generale SA, which forecasts a $220 billion reduction in bill sales in the current quarter following the latest borrowing revision. “Especially at a time when you’re seeing a decent amount of demand from investors for front-end products.”
Money-market funds — which typically hold T-bills alongside other short-dated securities — have ballooned to a record $6.1 trillion this month as a stronger economy and sticky inflation prompts Fed officials and the market to rein in expectations for rate cuts this year, augmenting their appeal.
The appetite for T-bills from these funds is also expected to climb. An upcoming rule change incentivizes moving capital into a specific type of money-market fund that almost exclusively buys T-bills, and away from those that also invest in higher-risk assets such as commercial paper.
QT Curveball
So where will all the cash go? Historically, a dearth in short-term assets has sent money 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 cash generated by the pandemic’s massive stimulus measures and the Fed’s quantitative easing sought a home.
Funds parked at this facility stayed around that level until last year’s glut of T-bill issuance prompted most — about $1.75 trillion — to exit between June and April.
That drop in excess liquidity focused attention on how far the Fed can shrink its balance sheet, a process known as quantitative tightening, before funding markets start to crack. Chair Jerome Powell said in March that the Fed would begin curtailing QT “fairly soon”; traders are watching for further details from the Fed’s Wednesday meeting on when that begins.
If thwarted T-bill investors stow their cash in the RRP, it could muddy the waters for ending QT by depriving the central bank of a clear view on liquidity. The Fed has said it’s watching RRP as it determines whether the market has ample liquidity.
“In terms of Fed’s QT, using this line of logic, you can argue perhaps they should continue QT for longer in light of this supply/demand imbalance,” said Bank of America’s Cabana.
By Carter Johnson and Alexandra Harris
