Wall Street is focusing on the November 4th quarterly borrowing plan, seeing it as a major unknown. Deutsche Bank expects to expand the size of its long-end bond buybacks beyond the $40 billion cap; Morgan Stanley expects to increase short-term Treasury bill and note issuance; Citigroup has listed the cut in 20-year bond auctions as a tail risk and has postponed expectations for large-scale auctions until 2028. U.S. Treasury Secretary Scott Bessent has taken a more proactive approach to national debt management, a shift that is disrupting the long-standing predictability of the U.S. bond market, prompting Wall Street to urgently speculate on significant adjustments that may occur in the government's borrowing strategy in the coming months.
According to Bloomberg's report on August 26, with last week's announcement of a bond buyback plan referred to by Bessent as the "Treasury Twist," the market's focus has quickly shifted to the Treasury Department's quarterly borrowing plan on November 4th. Wall Street investment bank strategists such as Bank of America and Deutsche Bank have warned that for the $31 trillion U.S. Treasury market, this upcoming announcement has become an unprecedented unknown.
Currently, mainstream Wall Street institutions predict that the Treasury may signal in November that future borrowing increases will be accomplished through short-term Treasury bills and shorter-dated notes, while further expanding buyback sizes to alleviate long-term yield pressures. Some banks even point out that the possibility of directly reducing the issuance size of long-term bonds, an aggressive option, is on the rise.
As long-term Treasury bond yields linger at multi-year highs, the Treasury's departure from the long-standing norm of "regular and predictable" practices is injecting new volatility into the market. Investors are facing a new era of U.S. debt management and are thereby reassessing the risk exposure of their portfolios.
November Borrowing Plan Becomes a Market "Unknown"
Bessent's recent moves have disrupted the long-standing tranquility in the U.S. policy-making arena. Meghan Swiber, Managing Director of U.S. Interest Rate Strategy at Bank of America Corp, stated that the bond market is entering "a whole new world of U.S. debt management."
Although Bessent currently rules out the possibility of making changes to regular auction plans and indicates that the Treasury will stick to the current schedule at least until the next borrowing announcement, market expectations have shifted.
BMO Capital Markets' U.S. Interest Rate Strategy Head, Ian Lyngen, pointed out that Biden's actions have effectively turned November's issuance statement into a big unknown. He emphasized that the possibility of reducing bond auction sizes can no longer be ruled out.
Furthermore, the Treasury made subtle wording adjustments in its latest issuance guidance, stating that officials are evaluating potential "changes" to future coupon and FRN sales, rather than the previous guidance of "increases." Analysts believe that this provides the Treasury with more flexibility to reduce long-end issuance.
Expanding Repos and Duration Shortening Strategy Game
As a first step in this adjustment, the Treasury may focus on repo operations. Deutsche Bank AG's strategy team, led by Steven Zeng, believes that the Treasury may increase the long-end operation size beyond the initially suggested $40 billion minimum.
Officials may even keep the operation size confidential until the day before the operation, reducing the predictability of repo plans and significantly raising the barrier for investors to short long-dated government bonds.
However, expanding repo operations alone is challenging to substantially alter the government's debt maturity profile. Unlike the Fed, the Treasury cannot conjure funds out of thin air to finance its purchases. This means repos must ultimately be funded through additional issuance (most likely short-term Treasuries) or using cash from the Treasury's account.
Morgan Stanley notes that the Treasury's account could provide $800 billion to $2 trillion for repos.
Morgan Stanley's Interest Rate Strategist, Martin Tobias, suggests that expanding repos alone may be just a transition until the November issuance plan is revealed. He believes that the event that will ultimately trigger market turbulence is the Treasury's method of shortening the weighted average maturity.
Tobias expects the Treasury to gradually increase sales of shorter-dated notes while keeping long-dated bond sales stable, but in the past week, the risk of directly cutting long-end bond auctions has increased.
Risks and Controversies of Reducing Long Bond Issuance
Some strategists are considering more aggressive reform plans.
Citigroup has delayed its forecast for a larger-scale auction until 2028 and raised the Treasury Department's ultimate potential to cancel the 20-year bond introduced by former Treasury Secretary Steven Mnuchin in 2020.
Despite its shorter term, the current yield of the 20-year bond is similar to that of the 30-year bond, which seems counterintuitive against the backdrop of a steepening U.S. yield curve.
Jason Williams, head of Citigroup's U.S. interest rate strategy, said that given the poor trading performance of the 20-year bond compared to the 10-year and 30-year bonds, the Treasury Department is likely to reduce its auction size, with the 20-year bond potentially benefiting the most from future actions.
However, reports suggest that directly cutting the issuance of long bonds faces practical challenges. The Treasury Department ceased selling the 30-year bond in 2001, but the fiscal backdrop was vastly different at that time, with a reduced budget surplus decreasing the government's financing needs. In the current environment of high issuance, any move to cancel a certain term bond would force other term bonds to absorb that borrowing.
Kevin Flanagan, head of investment strategy at WisdomTree, warned that reducing issuance at the long end of the curve and making up for it elsewhere seems mathematically very challenging. He said that if the Treasury Department goes down this path, the market will see it as manipulation, which could ultimately backfire.
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