Key Highlights

• The treasury secretary would like to see lower 10y yields
• Fiscal policy may not be congruent with that desire
• Extraordinary debt ceiling measures are getting closer to exhaustion

Achieving lower 10y yields requires policy support

EXHIBIT #1: TERM PREMIUM RISES WITH FISCAL DEFICITS

^{Source: BNY Markets, Federal Reserve Bank of New York, US Treasury Department, Bloomberg}

Our take

New Treasury Secretary Bessent last week remarked that he and the president would like to see lower benchmark yields in the US, rather than insisting on short-term rate cuts from the Fed. Bessent has argued that lower inflation stemming from lower oil prices – a result of the new administration’s evolving energy policy, would keep inflation expectations under wraps and lead to lower yields.

We are skeptical that lower oil prices alone will cap – let along reduce – 10y yields, and we would argue that other policies presumed to be on administration’s agenda are more likely to raise them. While we do acknowledge that inflation expectations are highly correlated with energy prices movements, we don’t think that the current level of yields is really the result of higher inflation expectations. 10y breakeven inflation expectations have really only moved up a few basis points since the election. 5y5y inflation swaps also are well behaved and below where they traded for most of 2023 and early 2024.

The Treasury’s most recent quarterly funding statement from last week envisioned very little change to issuance policy, but if we’re being honest, given how early we are into Bessent’s (and Trump’s) term, it was likely more of a placeholder than a forward-looking policy document. We think in subsequent quarters, the details will change and reflect increased coupon issuance in the second half of the year.

Forward look

A new budget agreement is needed by March 14, the day the current continuing resolution on spending runs out. We expect a complicated reconciliation process to kick off sometime later this month, and it should include extending the 2017 tax cuts, which expire at the end of 2025. The scoring of what we expect to be an expansionary budget, even with large spending cuts, could cause some “anticipatory indigestion” in the bond market, especially among cross-border investors, who – as we have frequently noted – have been relatively averse to buying longer-duration Treasurys.

Exhibit #1 shows how the term premium – the additional yield required by investors to fund the government – has evolved against the backdrop of fiscal policy. Higher deficits generally mean higher term premia, something at odds with the treasury secretary’s recently stated desire. Developments this month could reveal the expected sea of red ink associated with the administration’s budget proposals. Ballpark estimates of the increase in the deficit that would result from a 10-year extension of the tax cuts are around $5trn.

Extraordinary debt ceiling measures coming close to their limit

EXHIBIT #2: TREASURY GENERAL ACCOUNT AND T-BILLS OUTSTANDING

^{Source: BNY Markets, US Treasury Department}

Our take

Moving from the budget and tax policy to the current debt ceiling process, we expect this to be addressed – or at least broached – in the reconciliation process. While it’s tempting to assume the debt ceiling issue away, given Republican control of both houses of Congress as well as the executive branch, we think it could be trickier than that. With such a slim majority in the House, Speaker Johnson may have to rely on Democrats to get the budget passed. This sets up a more complicated process.

As we write, the Treasury is employing so-called extraordinary measures to continue to stay under the current debt limit, which went into effect at midnight on January 1. Treasury started to exploit these measures in late-January. On January 21, the department reported over $300bn in headroom due to these extraordinary measures, but as of February 5, only $133bn remained. See Exhibit #2.

The Treasury General Account is currently well above $800bn, so inevitably these monies will also be used to meet the government’s obligations until the debt ceiling is addressed. Mid-April tax collections will be ratcheted down due to a reprieve granted to California residents on the back of the southern California wildfires in January.

Forward look

The date on which Treasury will no longer be able to meet its obligations is unclear and there is no market consensus. If Treasury can make the money last until the end of May, then quarterly tax receipts due in June can push this date into late-July or even August, but we won’t have a good idea about this issue for some time. Nevertheless, the debt ceiling, which we first wrote about in early January, will likely become more important and receive greater market attention. We don’t yet see any effects on T-bill yields, but these should eventually start to appear, likely when bill issuance starts to fall in a week or two, which is likely also when we’ll see the TGA start to fall.