Interest Rate Market Seeks More Buyers

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AT-A-GLANCE

• As the Federal Reserve reduces its balance sheet, the supply of U.S. Treasuries could allow other entities to expand their own positions

• On its current trajectory, the U.S. Treasury will issue $23 billion fewer securities per month, leaving approximately $146 billion in net new duration issuance before the end of 2022

The U.S. Treasury market could see more buyers step up over the remainder of this year and into 2023 to compensate for lower buying activity by the Federal Reserve.

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Even though the Treasury will be issuing fewer bonds over that period, the lower supply does not outweigh the lower demand from the Fed. This means that the U.S. rates market will only balance if there is increased buying by other entities, including the private sector.

The Fed recently announced that they will look to reduce their buying by up to $522.5 billion in 2022 and $1.14 trillion in 2023. As the Fed reduces its balance sheet, other entities will see available supply of U.S. Treasuries grow, allowing them to expand their own positions.

The implications of the change in policy from both the Fed and the Treasury are just beginning to become clearer. As well as the greater reliance on non-Fed buyers, another important development is that the supply of government bonds will increase further down the curve relative to more prompt issuance.

One further development is that the changing market profile could also have a significant impact on the derivative markets: as the broader interest rates market needs to absorb more bonds, the potential hedging needs could be massive.

Big Issues

Treasury issuance, although slightly down, remains very high from a historical perspective.

In the context of the period from 2002 to 2021, the current level of debt issuance remains enormous. In recent years, Fed purchases helped to digest these elevated levels. Now, though, the Fed is materially capping the purchases it will make from principal repayments. 

On its current trajectory, the U.S. Treasury will issue $23 billion fewer securities per month or $184 billion less for the eight remaining months from May through December.

But, given $330 billion in fewer purchases by the Fed, this still leaves approximately $146 billion in net new duration issuance before the end of this year.

More Length

The reduction in Treasury refunding will be felt primarily in shorter duration bonds rather than in the long end, although the mid-point of the curve – the 7-year bond – will see the sharpest drop off in issuance.

In comparison, the long end – including the 10-, 20- and 30-year bonds — will only see a minor reduction. 

Quarterly Refunding Figures and Changes – Less Issuance

The U.S. Treasury typically targets a five-year duration profile for its issuance, but in recent years it has been issuing securities with a much longer duration.

The Treasury’s aim has been to actively extend the duration of its typical bonds in order to take advantage of the recent low-rate environment. Earlier this year, the Treasury reported that its debt-weighted average maturity had crept out to around six years, while the latest Quarterly Refunding Schedule implies a duration of slightly over eight years.