Last week, the market was quite optimistic ahead of the US Treasury's announcement of a public debt issuance plan for Q4/2023 lower than forecast. This is a welcome signal indicating that the US government is on track to restrain the pace of public debt accumulation, although there is still no specific direction in addressing US public debt at present.
This decision of the Treasury must come from timely consultations by TBAC (Treasury Borrowing Advisory Committee) - the US Treasury's Borrowing Advisory Committee. TBAC includes senior representatives from financial institutions on both the Sell Side and Buy Side in the market (including banks, dealers, brokers and financial funds…).
The information discussed by TBAC with the US Treasury carries significant value reflecting the overall trends in the financial market. Therefore, this week's macroeconomic article from Viet Hustler will summarize the important details in TBAC's presentation to the US Treasury.
TBAC emphasized technical issues of public debt and bond market reactions, including:
T-bond yields have increased at a rapid pace since the beginning of Q3, especially high increases for bonds with long maturities.
From the beginning of Q3 to 10/20, 30Y T-bond yields increased by +124bps, while 2Y T-bond yields only increased by +20bps.
Viet Hustler's equivalent analysis of the impact of changes on the Yield Curve on the economic outlook: Developments in the yield curve and economic warnings
The market raised predictions for the Fed's policy rate at the end of 2025 from 3.35% to >4.1% (increasing long-term rate predictions by +75bps).
This indicates market expectations that the Fed will maintain high rates for longer.
Possibly, high borrowing rates will be the new financial environment that businesses need to adapt to, ending the era of cheap money over the past decade.
TBAC emphasized that term premia played the main role in adjusting the balance of long-term and short-term bond yields in the recent period:
Term premia is the additional return that investors require to invest in long-term bonds, to compensate/hedge against interest rate risk during periods of high interest rate volatility like now.
In theory, term premia can be understood as the yield differential between long-term bonds and the yield from continuously refinancing short-term bonds over the same period.
(Example: yield of holding a 10Y bond to maturity and yield of refinancing 1Y bonds continuously over 10 years.)
But due to interest rate and inflation volatility, term premia cannot be calculated directly easily:
The most famous model for calculating term premia proposed by Adrian, Crump, and Moench (ACM), as well as models by Kim and Wright (KM), Gü rkaynak, Sack, and Wright (GSW), Hördahl and Tristani (HT)...
According to the latest research published by Fed NewYork, as of September, term premia continued to rise above 0% (ACM Model) and much higher than the 10-year average.
Bloomberg (& Financial Times) estimates also show that September term premia first exceeded 0% for both ACM and KM models since 2017.
According to TBAC: Term premia remained negative in the prior period due to QE policy and low interest rates making short-term asset yields (Money Market assets) near 0%.
(Thus, investors largely bought long-term bonds with higher yields, causing long-term bond yields to fall.)
Reasons for current high term premia: interest rate risk + risk of holding long-term bonds when the government is facing a debt crisis leading to a sell-off wave in long-term bonds => pushing long-term bond yields higher.
Banks reducing holdings of long-term bonds:
Foreign investors minimizing holdings of T-bonds:
According to TBAC advisors to the Ministry of Finance:
… when term premia are high, issuing more debt will further accelerate the re-pricing of long-term bonds in the market, pushing term premia even higher.
But if the debt growth pace slows, it will have a positive impact on term premia, and reduce bond yields, especially long-term bonds.
TBAC's analysis of information on public spending deficits and the US Treasury's public debt plan:
TBAC pointed out that based on historical data, larger budget deficits correlate with higher unemployment rates.
However, the budget deficit levels in 2021-2023 lie outside this correlation….
…. this may have led the Fed to confidently announce a larger-than-expected debt issuance plan in August 2023.
But the government's severe budget deficit drew market attention and strong reaction to the August debt issuance plan announcement: the main cause of the surge in 10Y T-bond yields.
Additionally, note that under pressure from reduced Treasury bond demand, coupon payments on auctioned bonds in the next 2 quarters are expected to increase further (higher than previous peaks).
This will further increase the government's debt costs and budget deficit situation, creating pressure for increased bond issuance in coming years.
This is a vicious cycle between rising bond yields and the volume of US government bonds that must be issued…
Changes in the US government's debt issuance plan ahead of TBAC's recommendations:
Pressure from high long-term bond yields will lead the government to issue more short-term debt.
Forecast from now until 2025, the amount of T-bills issued by the US Treasury will always exceed 20% of total government debt (while TBAC recommends 15-20%).
However, from a macroeconomic perspective, Viet Hustler still believes that reliance on short-term debt in the next 2 years will limit the government in long-term economic and infrastructure investment activities. This will affect long-term economic growth.
The US government has taken action to reduce expected borrowing in Q4/2023:
The Treasury announced last week that the government expects to borrow additional +USD 776 billion in Q4/2023,
(lower by -$76 billion compared to the July announcement and Q3 figure: ~+USD 1010 billion)
However, issuing additional debt is inevitable to pay for government expenditures and old debts:
Last Wednesday, the Treasury also announced it will auction a batch of bonds worth 112 billion USD next week to repay 102.2 billion USD in bonds maturing on 11/15…
…… that is, there will be more than +9 billion USD in debt raised next week additionally to pay for the government's bills…
As Viet Hustler has previously analyzed, the space for the US government to adjust its debt balance will be very limited in a high interest rate environment and uncontrolled inflation.
Debt-price spiral will create a conflict of objectives in the policy of the US government and the Fed.
Related articles: Geopolitical tensions - the straw that breaks the camel's back for the US public debt crisis?
CONCLUSION
Most of the analyses presented by TBAC have a certain technical nature, so Viet Hustler only summarizes some important information for readers above.
Previously, the principles of risk-reward balance in financial markets were disrupted due to the Fed's too rapid interest rate hiking process: short-term bond yields were higher than long-term bond yields. Yields from investing in Treasury bonds (assets considered relatively risk-free) have reached the level of yields from investing in corporate stocks (high-risk assets).
Currently, the Fed has paused the interest rate hiking process. Therefore, in agreement with Viet Hustler's previous analysis, TBAC also believes that the recent faster increase in long-term bond yields compared to short-term bonds stems from investors' adjustments to the risk-reward balance in the market, through the recent bond sell-off. In the near future, when companies start refinancing, there may be another adjustment that pushes corporate borrowing costs even higher.
Returning to the public debt issue, TBAC's recommendations on public debt balance have influenced the government's decision to issue new debt over the next 6 months. At least, the US government has exercised restraint in its borrowing plan for Q4/2023. Meanwhile, the Treasury is likely to increase short-term debt borrowing to avoid high interest rates on long-term loans. According to TBAC's forecast, until 2025, the value of US T-bill issuance will always account for more than 20% of the total outstanding government market debt.
Finally, besides the plan to slow down the process of increasing new debt and the plan to buy back old debt (buyback) next year, the US still has no stronger solutions for its pressing public debt issue.
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