Key Highlights

• Bill issuance has increased and looks set to continue along with government financing needs
•  Money market mutual funds have increased their allocations to USTs by almost the same amount as issuance
• Real money also shows inelastic demand for short end U.S. sovereign paper

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Larger bill auctions have been the norm lately

EXHIBIT #1:  LARGER BILL AUCTIONS

_{Source: BNY Markets, Bloomberg, U.S. Treasury}

Net T-bill issuance by the U.S. Treasury was over $650bn between June 30 and October 9. With the Republican budget deal passed at the beginning of June, the Treasury General Account (TGA) had been run down to just around $300bn. In its quarterly funding statement at the end of July, Treasury indicated its goal of returning the TGA to its pre-debt ceiling level of $850bn. Bill issuance has in large part helped refill the TGA to about $800 currently.

Exhibit #1 shows that compared to the previous two years, the size of T-bill auctions has increased notably in recent weeks and months, and this week is no exception, with Treasury announcing increased auction sizes for the upcoming placements. As Exhibit #1 shows, the increase in bill offerings is well in excess of those for coupons.

This continues a familiar pattern of late – meeting the government’s financing needs by issuing paper along the shorter end of the curve. In December 2019, 6% of all U.S. public debt outstanding was represented by T-bills. With the increase in government spending that ensued with the pandemic, by December 2020 bills represented 13% of all government debt outstanding, and by the end of September this year, they were 17%. This doesn’t mean that coupon issuance has retreated in an overall sense, just relative to short-end supply. With the next quarterly funding statement, out in the first week of November, we’ll probably see a continuation of this trend.

With the administration eyeing policies to keep long-end yields contained, skewing financing needs toward the front end is one of its levers. Others include targeted buybacks (to increase off-the-run liquidity), advocating reducing the supplementary leverage ratio (intended to induce banks to hold more sovereign debt), and other measures aimed at reducing supply and increasing demand at the back end of the curve.

Inelastic demand appears to alleviate concerns about market indigestion

EXHIBIT #2: : MMFS REALLOCATING BACK INTO BILLS

_{Source: BNY Markets, Crane Data}

Money market mutual funds (MMFs) have seen an increase in AUM of around $250bn since the end of June (through the end of September), according to Crane Data. Notably, MMFs have increased their holdings of Treasurys by over $600bn during the same time. This is almost equivalent to the net issuance of T-bills mentioned above ($650bn), but around two-and-a-half times the increase in MMFs’ assets over the same period.

Exhibit #2 shows the change in MMFs’ asset allocation, focusing on repo and Treasury holdings, since the end of last year. Note that at the end of December last year, MMFs were allocated 42.4% in USTs, and 36.4% in repo. These relative percentages are fairly normal outside of debt ceiling periods. But by the end of June, with few bills on offer, money market funds were forced into repo, with asset allocation during that period essentially reversed: 35.4% in T-bills, and 42.2% in repo. At the end of September, we saw a second reversal of these patterns, with asset allocations at 42.4% Treasurys and 36.4% repo. This suggests that bill demand from MMFs is rather inelastic, increases in supply will be met with increases in demand.

EXHIBIT #3: IFLOW SHOWS DEMAND FOR BILLS IS NEARLY INELASTIC

_{Source: BNY Markets, Federal Reserve Board of Governors, Bloomberg}

Our own iFlow data show similar patterns of behavior on the part of real money investors. While we don’t report sovereign bond buying in total dollars, we can see the direction and relative magnitude of flows into or out of the asset class. Furthermore, we can drill down into the 0–1y segment of the Treasury curve. In Exhibit #3, we plot a 20-day moving average of flows into this part of the curve and overlay it with the 20-day rolling sum of net T-bill issuance. Once again, demand for bills from institutional investors is nearly inelastic to supply.

Forward look

These observations suggest that the market will not experience indigestion with respect to growing bill supply. Demand exists within current reasonable levels of issuance, at least so far. In its last financing report in late July, Treasury indicated that it expected to borrow $590bn in marketable debt, and we expect bills to make up a similar share of the financing vehicle. As long as the borrowing estimate is indeed near that level, the market should be able to absorb the increased supply.

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