April 30th, 2014 10:38 am | by John Jansen |
Via TD Securities :
The May Treasury refunding announcement brought few surprises, with improving budget dynamics allowing Treasury to announce a cut to 3yr auction sizes to $29B from $30B. Treasury noted that improving budget dynamics will allow them to cut front-end coupon auction sizes further in the coming months, with increasing revenues and falling outlays decreasing deficit projections. Nevertheless, with budget deficits projected to rise starting in 2016, Treasury remains cautious about cutting auction sizes too sharply given the likely increase in future funding needs.
Treasury’s projections suggest that it will trim 2yr and 3yr auction sizes gradually over the coming months, cutting monthly issuance by $1B in each issue. The projections suggest that we can expect 2yr auction sizes to decline to $28B from $32B over the next 4 months and 3yr auction sizes to fall to $26B from $30B last month. While we suggested that improving budget dynamics leave Treasury with ample room to trim 5yr auction sizes in the coming months, Treasury appears reluctant to project a cut in the size of its most actively traded on-the-run issue. We can therefore expect auction size cuts to be contained to the 2yr and 3yr maturities over the coming months, accompanied by reductions in bill issuance as Treasury remains on track to be overfunded by $115B during FY2014. Alongside the Fed’s insistence that rates will remain low for a considerable time, we expect the cuts to front-end coupon auction sizes to keep the front-end of the curve well-supported.
Smoothing the auction calendar, but further study required
While Treasury questioned dealers about eliminating 10yr and 30yr reopenings in order to smooth its lumpy repayment schedule, the May refunding meeting brought little progress on this front. In fact, Treasury explored 3 primary options for changing its funding schedule in order to decrease its susceptibility to short-term shocks:
1) Increasing the size of Treasury’s operating cash balance – This option could prove easiest for Treasury to implement in the near-term as borrowing needs are projected to increase substantially starting in 2016. Increasing its operating cash balance would allow Treasury to more easily weather short-term funding shocks without making wholesale changes to its auction calendar.
2) Modify quarterly 10yr and 30yr auction schedule to new monthly issuance – While this option could be viable for the 10yr maturity down the road, the committee highlighted its fears that removing reopenings in 10s and 30s could lead to reductions in the liquidity of on-the-run issues. This option would best address Treasury’s underlying concerns of repayments being concentrated in 4 refunding months, but would entail significant alterations to the auction schedule. While this option could be viable in the future, Treasury will need to study the potential effects of the change further before making any changes.
3) Shifting 3yr issuance to non-refunding months – This is another potential change to the auction calendar which could help alleviate the lumpiness of Treasury’s repayment schedule, and could prove less damaging to liquidity than the elimination of 10yr and 30yr reopenings. Nevertheless, we suspect that further study will remain necessary before Treasury decides to shift the timing of 3yr auctions.
Overall, aside from cuts to the sizes of 2yr and 3yr auctions, we expect few changes to be made to Treasury’s funding schedule. Treasury is likely to continue exploring ways of decreasing its susceptibility to funding shocks, but we do not expect wholesale changes to the auction calendar to be made in the near-term.