Treasury bill supply could rise by $1 trillion by the end of 2023, but the impending debt ceiling episode will complicate the timing, according to Bank of America strategists.
Strategists Mark Cabana and Katie Craig estimate Treasury will issue about $193 billion of bills in 4Q 2022 and $257 billion in 1Q 2023, with particularly strong months of supply in November, February and March because they are typically heavy deficit months that require additional issuance to sustain the cash balance
However, bill supply projections and the associated market impact are complicated by uncertainty around the timing of the debt limit, another round of money-market reform and the Federal Reserve’s quantitative tightening
Positive quarters of bill supply should help cheapen bills relative to overnight index swaps, and strategists estimate spreads should narrow by 10 basis points or more
Still, the monthly path of bill issuance is “much less clear” because of the debt ceiling, which could become constraining as early as December 2022
At that point Treasury would enter a debt issuance suspension period, which would restrict their ability to issue debt -- likely cutting bills to keep coupon sizes unchanged
Strategists project the potential default, or x-date, would be in August or September 2023. After that, there would be a surge of bill supply to replenish the cash balance
The big question for anyone issuing debt is whether there is a sufficiently large pool of willing buyers to support the market. The Bank of Japan has been buying bonds for so long that it has largely crowded out the domestic market. Liquidity in the 10-yeasr is at an all time low. This condition raises important questions for the US government because $1 trillion deficits appear to be the norm.
The US government has had the luxury of relying on big sovereign buyers of its debt for decades. China, Japan and Saudi Arabia were big buyers of debt for decades but that is now changing. To get an accurate picture of this story I created a chart of the US Dollar reserves of the 10 largest holders. That’s China, Japan, Switzerland, Russia, Taiwan, India, Saudi Arabia, Hong Kong and South Korea.
The total hit an initial peak in 2014 and failed to hold the move above $9 trillion in 2021. The $900 billion fall this year in US Dollar reserves goes a long way towards explaining the continued weakness in the bond Treasury market.
Treasury yields are now in excess of 4% at maturities from 3-month to 30-years. In normal circumstances that would encourage demand. The big question for investors is what will be required for the US government to return to sound fiscal doctrine. Without measures to control deficits it is going to be increasingly difficult to sell its debt. That means a higher risk premium on US assets and long-term support for hard or limited supply assets.