Lack of Supply

November 30th, 2015 7:32 am | by John Jansen |

Via Bloomberg and thank you to Steve Liddy for forwarding:

There’s a Big Drop in U.S. Treasury Debt Supply Coming in 2016
2015-11-30 11:24:45.925 GMT

By Liz Capo McCormick and Daniel Kruger
(Bloomberg) — Lost in the debate over the U.S. Treasury
market’s resilience as the Federal Reserve starts to raise
interest rates is one simple fact: supply is falling — and
Net issuance of U.S. notes and bonds will tumble 26 percent
next year, according to estimates by primary dealers that are
obligated to bid at Treasury debt auctions. The $433 billion of
new supply would be the least since 2008.
While a narrowing budget deficit is reducing the U.S.’s
funding needs, the Treasury has shifted its focus to T-bills as
post-crisis regulations prompt investors to demand a larger
stock of short-term debt instead. The drop-off in longer-term
debt supply may keep a lid on yields, providing another reason
to believe Fed Chair Janet Yellen can end an unprecedented era
of easy money without causing a jump in borrowing costs that
derails the economy.
“Longer-term yields will be slower to move up next year
because the Treasury will be funding more with bills,” said Ward
McCarthy, the chief financial economist at Jefferies Group LLC,
who has analyzed U.S. debt markets for over three decades and
was a senior economist at the Richmond Fed. “There is also a
global appetite for Treasuries as U.S. debt is one of the
world’s highest-yielding and is among the most liquid markets.”
Excluding bills, Jefferies forecasts net issuance of $404
billion in 2016, down from their $607 billion estimate for this
Of the ten estimates compiled by Bloomberg, the Bank of
Montreal was the lone primary dealer calling for an increase in
2016. Net issuance of interest-bearing securities, or those with
maturities from two years to 30 years, has fallen every year
since the U.S. borrowed a record $1.61 trillion in 2010, data
compiled by the Securities Industry and Financial Markets
Association show.

Debt Auctions

Deutsche Bank AG says net sales could even fall as low as
$293 billion, based on a scenario where the Treasury reduces
debt auctions by 8 percent across the board to make room for
more bills. That would represent a more than 50 percent drop
from the bank’s 2015 projection of $629 billion.
After the market for Treasuries more than doubled since the
financial crisis to $12.8 trillion as the government ran
deficits to bail out banks and support the economy, the U.S. has
started to scale back supply.
One reason is the narrowing budget gap. With the Fed
holding its benchmark rate near zero since December 2008, the
jobless rate has fallen by half from its post-crisis peak in
2009, to 5 percent today. As tax revenue increases, the
Congressional Budget Office forecasts the shortfall will narrow
to $414 billion in the fiscal year ending Sept. 30, 2016, from
$439 billion in the previous 12 months and $483 billion in the
prior annual period.
To lock in record-low long-term borrowing costs, the
government has also lengthened the average maturity of its debt
to 5.8 years from 4.1 years at the end of 2008. One consequence
is that the Treasury market’s share of bills has shrunk to about
10 percent, the smallest in Bloomberg data going back to 1996.
The Treasury and Wall Street strategists say it’s now time
to reverse that to build the government’s stores of cash and as
post-crisis regulations increase demand for ultrasafe, short-
term assets like bills.
“The Treasury had previously focused on raising the
maturity of their debt,” said Jay Barry, a U.S. fixed income
strategist at JPMorgan Chase & Co. Now, “they can focus on
increasing bill issuance as demand is set to rise.”

Bill Supply

The government will boost bill supply by $173 billion in
2016, according to JPMorgan, another primary dealer. That would
be the biggest increase since 2008. The bank also sees net
Treasury sales of coupon-bearing securities falling to $313
billion next year, compared with their 2015 estimate for $627
The dwindling net issuance may keep Treasury yields in
check as the Fed moves to raise rates for the first time since

Liftoff Odds

While traders are pricing in a 72 percent chance the Fed
will lift rates from near zero in December, they still see the
rate below 1 percent in a year’s time. Forward rates imply that
traders also expect yields on 10-year notes, used to set
interest rates on everything from mortgages to corporate bonds,
will rise to about 2.5 percent over the same period — less than
0.3 percentage points above the level of 2.24 percent at 6:24
a.m. New York time.
Still, demand for Treasuries could diminish because of
increased competition from corporate borrowers, according to
Aaron Kohli, a fixed-income strategist at Bank of Montreal.
They’ve sold $1.5 trillion of bonds this year, a record pace,
focusing on longer-maturity securities before the Fed starts its
tightening cycle.

Changing Picture

And the picture would change rapidly if the Fed decides to
stop reinvesting the money from the maturing debt it owns back
into Treasuries. The Fed has amassed $2.5 trillion in
Treasuries, largely from its quantitative-easing programs, and
has $216 billion of the debt coming due in 2016.
On the other hand, Fed officials have repeatedly said they
will raise rates gradually, which may ultimately help avert a
sudden selloff in bonds. Mutual fund investors bought a record
42 percent of the $1.6 trillion in notes and bonds sold at
auctions through September, up from 18 percent in 2011.
Treasuries will be underpinned by the fact that yields on
10-year notes are already higher than 18 of 25 developed
countries tracked by Bloomberg and the highest among the Group
of Seven nations. The yield advantage over comparable German
bunds reached 1.78 percentage points Nov. 20, the most since
“We are in a new environment where low yields are the
norm,” said Mike Lorizio, a Boston-based fixed-income trader at
Manulife Asset Management, which oversaw $313 billion as of June
30. Lorizio has been a buyer of Treasuries this year and sees
value in 10- and 30-year debt. “So Treasuries look attractive.”
Estimates for 2016 net issuance of Treasury coupon
* Deutsche Bank — $293 billion *
* JPMorgan — $313 billion
* Nomura — $323 billion
* Citigroup — $402 billion
* Jefferies — $404 billion
* Morgan Stanley — $407 billion
* Barclays — $461 billion
* TD — $472 billion
* Credit Suisse — $560 billion
* Bank of Montreal — $585 billion

Note: Deutsche Bank’s estimate assumes an 8% cut in coupon

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