Delta variants, crazy spending, inflation fears and debt ceilings all threaten to fool U.S. bonds, and yet it’s the delicate and often misinterpreted dance between the Fed and the Treasury that is likely in control.
On the one hand, the Federal Reserve will likely start cutting cash purchases by $ 80 billion per month by the end of the year – a time many investors feared would undermine the market and drive up yields. .
But the US Treasury will also borrow less in the coming year, with a budget deficit and funding needs rapidly declining from the eruptions of 2020.
All other things being equal, if the gradual exit of the largest buyer from the market is accompanied by an equivalent reduction in the supply of new debt, the two should cancel each other out in terms of price. And maybe that’s what the seemingly peculiar stability of the bond market is telling us since April.
The question is whether one of these forces ends up dominating – or if they are deliberately kept in sync.
The exact numbers or timing of the Fed’s tapering are of course still unknown, let alone details of which part of the Treasury’s maturity spectrum will concentrate debt sales. Wider developments in growth and inflation remain critical and unknown variables.
But the basic dynamics are a powerful stabilizer.
Joseph Wang, a former senior trader at the Fed’s open markets office, believes the two “will pretty much cancel each other out … so the stock of private sector treasury holdings will continue to grow at about the same rate.” The Fed will only own a smaller share of the overall stock. “
On the financing side, the Treasury will borrow much less during fiscal years 2022 and 2023 than this year thanks to the resumption of economic growth and tax revenues, a reduced need for support at the level of the crisis for individuals and businesses, and new expense bills pushed further into the future.
This will result in a smaller debt increase program. The Treasury Borrowing Advisory Committee, a group made up of key players in the fixed income market, says its baseline scenario calls for a 19% reduction in coupon issuance in calendar year 2022 to achieve a cumulative reduction of 35% 12 months later.
It should also be noted that the Treasury begins next year after borrowing large amounts in the year following the outbreak of the COVID-19 pandemic. TD Securities’ Gennadiy Goldberg estimates that the net coupon issuance in fiscal 2021 was $ 2.73 trillion, up $ 1.37 trillion from the previous year.
But all was not necessary, one of the main reasons the Treasury’s cash balance at the Fed has inflated and distorted at the ultra-short end of the curve, and why borrowing will be lower on it. next year.
According to TBAC’s basic recommendation, gross issuance of 2-30-year bonds is expected to fall by $ 749 billion to $ 3.21 trillion in 2022, then fall further to $ 2.590 billion in 2023.
The net amount will largely depend on the government’s budget plans. Despite the headlines of the Biden administration’s ambitious $ 3.5 trillion spending plans over the next decade, U.S. fiscal policy will tighten significantly in 2022 and 2023.
The bipartisan Congressional Budget Office estimates that the 2021 fiscal deficit of $ 3 trillion, or 13.4 percent of GDP, will drop sharply to $ 1,153 trillion, or 4.7 percent of GDP over the course of the year. fiscal year 2022, and $ 789 billion, or 3.1%, in fiscal year 2023.
In terms of financing needs, the CBO projects a net borrowing requirement of just under $ 1.5 trillion in FY2022, falling to about $ 750 billion in 2023. This compares to a just under $ 2,000 billion this year.
The Fed, meanwhile, is expected to present its cut schedule before the end of this year and start cutting its treasury bill purchases next year. At $ 80 billion a month right now, he accumulates $ 960 billion a year.
If it declines at a steady rate of $ 10 billion to $ 15 billion per month, new purchases will cease in about six to eight months.
In fiscal 2022, however, the Fed will still rack up over $ 500 billion in new purchases. Still, it will be about $ 400 billion less than in 2021, roughly similar to the decline in the government’s net financing needs.
If the Fed’s $ 960 billion bond purchases in 2021 are reduced to zero in FY2023, that again roughly offsets the $ 1,000 billion reduction in the government’s financing needs in the past. during the same period, according to CBO estimates.
A host of other factors will determine the market price of the Treasury in the years to come, such as President Joe Biden’s stimulus and tax hike plans, and the direction inflation and expectations take. inflation.
But changes in Fed demand and Treasury supply could provide the general framework in which everything else takes place.
Source: Reuters (by Jamie McGeever; edited by Andrea Ricci)