US Treasury Expected to Reject Changes to Treasury Issuance Guidelines; Short-Term Debt "Dependency" May Face Interest Rate Impact Risks

According to Zhitong Finance APP, the debt management team led by U.S. Treasury Secretary Janet Yellen has long refused Wall Street's suggestions to adjust future U.S. Treasury issuance guidance, to the point where many primary dealers no longer expect relevant policy changes in the short term. Before the quarterly debt strategy statement is released on Wednesday, most primary dealers expect the Treasury to reaffirm its previous position, namely that it will not increase the issuance of medium- and long-term Treasuries (notes and bonds) for “at least the next several quarters.”

This forward-looking guidance dates back to the Biden administration. Yellen has previously criticized this approach, arguing that its purpose was to suppress long-term borrowing costs ahead of the November 2024 election. Now, facing midterm elections is the Republican government led by President Trump, and any signal hinting at an expansion of bond auction sizes could drive U.S. Treasury yields even higher, which would not serve the interests of the administration.

Last week, the yield on the 30-year U.S. Treasury reached its highest level since 2007. Given that the financing costs for long-term bonds are already much higher than for short-term bonds, many dealers are skeptical about whether the Treasury will truly expand the issuance of long-term Treasuries in the coming years.

Since taking office, Yellen has relied on short-term Treasury bills (with a maturity of up to one year) to meet the government's growing funding needs. Because rates on short-term bills are relatively low, this strategy has helped contain the Treasury's borrowing costs. However, this approach also brings risks—ongoing reliance on short-term bills means that the cost of servicing debt will be more vulnerable to shocks from short-term interest rates, especially as investors are betting that the Federal Reserve may be forced to tighten monetary policy in the coming months.

The U.S. Treasury is highly reliant on short-term bills to meet funding needs

Blake Gwinn, head of U.S. rates strategy at RBC Capital Markets, commented: “The Treasury should keep more options open by adjusting its guidance. While such a move could risk pushing yields higher, this shift will have to happen sooner or later. The longer the wait, the more important and impactful the end of this guidance could be for the market.”

The Treasury will update its financing needs estimate for the current quarter on Monday, followed by the so-called “quarterly refunding announcement” on Wednesday. In May, the Treasury estimated net financing needs of $671 billion for the three months through September.

According to calculations by Bank of America, if the Treasury keeps the issuance volume of coupon-bearing securities (notes and long-term bonds) unchanged through the end of the 2027 fiscal year, the proportion of short-term bills in the government's outstanding debt would rise to nearly 25%, the highest level since 2004 (excluding anomalies during the COVID-19 pandemic and the global financial crisis). The Treasury Borrowing Advisory Committee had previously recommended an average ratio of about 20% for short-term bills.

As for the continued reliance on short-term bill financing, the Treasury currently has reason to believe that strong demand can at least temporarily absorb the additional supply. According to Crane Data LLC, the size of money market funds has now grown to about $8.3 trillion.

Yellen also indicated that stablecoin issuers could become a new source of demand for short-term bills in the future. Meanwhile, the Federal Reserve is increasing its holdings of Treasuries, partly by reinvesting proceeds from maturing mortgage-backed securities into short-term bills.

Since the last quarterly refunding announcement in May, dealers have been delaying their forecast for when the Treasury will begin increasing the size of coupon-bearing security issuance, with many now expecting this shift to happen no earlier than May 2027.

As for next week’s refinancing auctions, if the volumes remain unchanged they will include: $58 billion of 3-year Treasuries to be issued on August 11; $42 billion of 10-year Treasuries on August 12; and $25 billion of 30-year Treasuries on August 13.

Economists predict that the U.S. federal budget deficit will remain around $2 trillion a year over the next few years, meaning the government will have to keep increasing borrowing. Over time, the large volume of maturing debt means the current auction sizes will not be sufficient for the Treasury to raise new funding.

J.P. Morgan analysts believe that the Treasury will face a "financing gap" starting from fiscal year 2027 (beginning October 1). The bank expects the cumulative financing gap from 2027 to 2030 to reach $3.7 trillion.

A J.P. Morgan strategy team led by Jay Barry wrote in a refinancing preview report last week: “From a prudent debt management perspective, we believe the Treasury should remove the word ‘at least’ from the longstanding forward guidance next week.” However, they added: "Political considerations are at play." They noted that the Trump administration has an incentive to avoid a rise in Treasury yields ahead of the election. In addition, Yellen has also paid close attention to lowering long-term yields.

A minority of institutions expect the Treasury to adjust guidance

Although most primary dealers expect the Treasury to reaffirm its stance of not increasing the issuance of medium- and long-term Treasuries (notes and bonds) for “at least the next several quarters,” some banks—including Deutsche Bank, Wells Fargo, and CIBC Capital Markets—believe the Treasury may adjust issuance guidance on Wednesday to prepare for an earlier increase in coupon-bearing security issuance. While the specific wording could take various forms, the key is to give the Treasury enough flexibility to potentially announce a policy adjustment as early as February next year.

However, market confidence in this change remains low. The Wells Fargo team led by Michael Pugliese stated: "We would not be surprised at all if the Treasury once again avoids adjusting its language, especially as the November refunding announcement will be released the day after Election Day." But the team also believes: "Based on the fundamentals and previous recommendations from the Treasury Borrowing Advisory Committee, this change should ultimately occur."

The Treasury Borrowing Advisory Committee consists of investors, primary dealers, and other market participants. In the future, when the Treasury eventually increases coupon-bearing security issuance, most dealers expect the additional issuance to be concentrated in short- and medium-term bonds, rather than longer-dated 10-, 20-, or 30-year bonds. The so-called “belly” of the yield curve is currently under less pressure. As of last weekend, the yield on the 5-year Treasury was about 4.45%, lower than the 10-year at 4.73% and the 30-year at 5.27%.

In May, the Treasury said officials were studying the possibility of increasing coupon-bearing security issuance, "with a focus on structural demand trends and the potential costs and risks of different issuance structures." TD Securities strategists Gennadiy Goldberg and Molly Brooks wrote in a report: "This language suggests that any future increase in coupon-bearing security issuance is likely to favor the front end of the yield curve."

Dealers will also be watching to see if the Treasury provides more details on its interest in investing some surplus cash in the repo market. Treasury officials have previously asked primary dealers for feedback on this initiative during the routine pre-refunding survey.