The Federal Reserve may have to adjust its bond-buying programme to adapt to the enormous issuance of long-dated debt lined up by the Treasury department, strategists say.
Government bond prices dipped on Wednesday, pushing yields up from close to record lows across a range of maturities after the Treasury outlined plans to next week sell a record $112bn of debt maturing in three, 10 and 30 years.
It also announced large increases to the auction sizes of its long-term debt over the next three months to fund the record-setting relief packages passed by US legislators since March and the new stimulus bill currently being hashed out by Congress.
Strategists now warn of potential bond market indigestion if the US central bank does not eventually shift the focus of its bond purchases towards long-term debt.
“The Treasury is increasing pressure on the Fed to extend the duration of their purchases,” said Priya Misra, global head of rates strategy at TD Securities. “It is almost a necessity now. Without that, we could have a messy Treasury market both in terms of functioning and auctions.”
Auction sizes for 10-year bonds will increase by $6bn from the previous quarter to $38bn, the Treasury said on Wednesday, while those for the 20-year and 30-year bond will rise by $5bn and $4bn, respectively.
Taken together with the planned uptick in auction sizes for two-, three- and five-year notes as well as other instruments, the Treasury said that amounted to an additional $132bn of issuance over the next three months compared to the previous period.
Up to now, bond investors have largely ignored the global pick-up in government debt issuance, wagering that it will be offset by central banks’ similarly vast bond-buying programmes.
But the magnitude of the latest issuance increase took market participants by surprise.
Immediately after the announcement, 10-year Treasury prices dropped, sending yields higher from the record low levels reached on Tuesday. The yields on 20- and 30-year bonds also rose, as did those for notes maturing in seven years.
At the height of the financial panic in March, the Fed pledged to buy an unlimited quantity of government debt, seeking to tame strains that had emerged in the world’s largest bond market.
Having once purchased as much as $75bn of Treasuries a day, the Fed has since scaled back the pace of its bond-buying. It now buys roughly $80bn a month across all maturities. Analysts say the need to shift purchases is not urgent, but it could become more pressing as the year progresses.
The purchases, coupled with heightened investor demand in the face of a dimming economic outlook, have helped to push Treasury yields to all-time lows, but the coming wave of issuance of longer-dated debt could alter this dynamic, strategists say.
Moreover, they warn that the borrowing estimates put forward by the Treasury — an additional $2.2tn by the end of the year — could swell even further if yet another fiscal stimulus package beyond the one currently under debate is delivered.
Previously, the Treasury had relied on the market for Treasury bills, which mature in one year or less, to meet its borrowing needs, and markets digested the new supply with ease. But, according to Subadra Rajappa, head of US rates strategy at Société Générale, demand for long-dated debt can be spottier.
“The risk is that you may not see demand materialise on an ongoing basis,” Ms Rajappa said, adding that it would help for the Fed to shift out the average maturity of its Treasury holdings.
Jon Hill, a rates strategist at BMO Capital Markets, characterised the Treasury’s auctions increases as “aggressive”, adding that the lacklustre economy provided an even more pressing reason for the Fed to adjust its bond-buying programme.
“[Inflation expectations] are low and the economy is still struggling,” he said. “Back in March and April the Fed was focused on market functioning. Now, things have calmed dramatically but we still need quantitative easing to compress long rates and lower borrowing costs.”