Source: Wall Street Journal
With the large-scale tax cuts and spending bill of the Trump administration officially implemented, the U.S. Treasury may begin a "surge of supply" in short-term Treasury Bonds to compensate for future trillions of dollars in fiscal deficits.
The market has already begun to respond to future supply pressures. Concerns over oversupply of short-term Treasury Bonds have been directly reflected in prices—yields on one-month Treasury Bonds have seen a noticeable increase since Monday. This signifies that the market's focus has completely shifted from the earlier concerns over selling long-term 30-year bonds to the front-end of the yield curve.
With a trillion-dollar deficit looming, the U.S. short-term Treasury Bond market will face a "surge of supply."
The enactment of the new bill brings a grim outlook for future fiscal conditions. According to estimates from the non-partisan Congressional Budget Office (CBO), the bill will add as much as 3.4 trillion dollars to the national deficit for the U.S. from fiscal years 2025 to 2034.
Faced with enormous financing needs, issuing short-term Treasury Bonds has become a cost-effective choice preferred by decision-makers.
First, from a cost perspective, although the yields on short-term Treasury Bonds with a maturity of one year or less have climbed to over 4%, they are still significantly lower than the nearly 4.35% issuance rate on ten-year Treasury Bonds. For the government, in a context where interest expenses have become a heavy burden, lower immediate financing costs present a strong attraction.
Secondly, this aligns with the clear preferences of the current administration. Previously, President Trump himself has expressed a preference for issuing short-term securities rather than long-term bonds. Treasury Secretary Bessent has also stated to the media that increasing the issuance of long-term bonds "makes no sense" at this juncture.
However, this strategy is not without risks. Relying on short-term financing may expose borrowers to fluctuations in future financing costs or greater risks. An anonymous Canadian Bonds portfolio manager stated:
"Whenever you finance a deficit with very short-term notes, there is a risk of shocks that may put financing costs at risk."
For example, if inflation suddenly rises, the Federal Reserve may have to consider raising interest rates, which would increase short-term financing costs as Treasury yields rise. Additionally, an economic recession and shrinking economic activity may lead to reduced savings, lowering demand for short-term notes.
Supply and demand face-off: Can 7 trillion in liquidity catch the wave of bond issuance?
The supply gates are about to open, making the market's capacity to absorb the new supply a core issue. Currently, the market seems confident, with its strength coming from the massive liquidity built up in the money market.
Looking at the supply side first. The U.S. Treasury Borrowing Advisory Committee (TBAC) recommends that the limit for short-term Treasury bonds as a percentage of total outstanding debt be around 20%. However, the interest rate strategist team at Bank of America predicts that to digest the new deficit, this ratio could soon climb to 25%. This means the market needs to be ready for short-term note supply that far exceeds the official recommended level.
The market's focus has dramatically shifted as a result. Just this past April and May, investors' anxiety was centered on the sell-off of 30-year long-term Treasury bonds and the risk of their yields soaring above 5%. Now, the spotlight has turned entirely to the other end: will short-term Treasury bonds lead to new turmoil due to oversupply?
Turning to the demand side, Matt Brill, head of North American investment-grade credit at Invesco Fixed Income, believes that the market's $7 trillion MMF is showing "continuing demand" for front-end debt, and it seems that the U.S. Treasury is also aware of this.
Mark Heppenstall, the President and Chief Investment Officer of Penn Mutual Asset Management, is more optimistic, stating:
"I don't believe the next crisis will come from short-term government bonds, as many people want to get their capital working, especially when real yields look quite attractive. You might see some pressure on short-term government bond rates, but there is still a lot of Cash / Money Market flowing in the market.
If problems do arise, the Federal Reserve will find ways to support any supply and demand imbalances.
Editor/jayden
