Key Highlights

• Treasury identifies August for the X-date; T-bills cheapen
• UST yields continue to rise; term premium the cause
• Even at current levels, Treasurys aren’t cheap enough to attract cross-border demand

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X-date in August, bills cheapen

EXHIBIT #1: STARTING TO EYEBALL AN AUGUST X-DATE

_{Source: BNY Markets, Bloomberg}

Our take

Treasury Secretary Bessent, in a May 9 letter to House Speaker Johnson, indicates that “there is a reasonable probability that the federal government’s cash and extraordinary measures will be exhausted in August, while Congress is scheduled to be in recess.” This ballpark estimate of the X-date squares with our own thinking and generally aligns with the Wall Street consensus. A few weeks ago, after the conclusion of the April tax filing season, we put forth a similar view (see here). The Treasury’s general account with the Fed (TGA) swelled by over $300bn in mid-April, and currently sits at around $575bn, while “extraordinary measures” available to Treasury currently add another $95bn to the monies available under the debt ceiling.

After the publication of Secretary Bessent’s letter, we have seen the first indications of a potential August X-date reveal themselves in the T-bill curve. Exhibit #1 compares the yields on the bill curve on Monday morning, May 12, to those of a week prior. Note that the gaps in the blue line for the May 5 date are for bills that have been issued over the past seven days. Within the highlighted area, which corresponds to the August X-date window, we see a distinct “hump” in rates for that period. Investors, now with some clarity, are beginning to lighten up on those bills which mature during that time.

Note that after September, the curve slopes increasingly downward, almost assuredly indicating investors’ expectations of Fed rate cuts later in the year. With the U.S. and China stepping back from the brink of a trade war – at least temporarily − yields across the UST curve have risen, as fears of a recession and expectations of aggressive Fed policy rate cuts in H2 2025 have both receded.

Forward look

The politics of the debt ceiling are going to become more acute, and as the Secretary’s letter indicates, the X-date is likely to occur while Congress is out of Washington for its summer recess. This suggests – a point that is addressed in the Secretary’s letter – that the reconciliation package for the budget and fiscal plan, which also includes addressing the debt limit, must be completed before the August break starts. If Congress cannot pass the full reconciliation package in time, the debt ceiling portion of the bill would have to be removed and addressed separately, potentially requiring some Democratic support, which could be politically perilous and make passage difficult.

Rising yields still not high enough to induce overseas buying at the long end

EXHIBIT #2: REAL YIELDS AND TERM PREMIUM DRIVE THE 10Y NOTE

_{Source: BNY Markets, Bloomberg, Federal Reserve Bank of New York}

Our take

With the news over the weekend of a cooling in the trade war between China and the U.S., risk markets rallied sharply on Monday, and Treasury yields across the coupon curve rose significantly. As of this writing, the 10y yield is above 4.45%, as expectations of a trade war-induced recession and potential Fed rate cuts to deal with economic softening are dialed back. We aren’t yet sure if things will change materially during the 90-day pause in the reciprocal tariffs and aren’t yet willing to change our recession call (which reflects a 50% chance of a recession). However, we do acknowledge that some relief is warranted.

We find the drivers of the recent increase in yields noteworthy. After the volatility of April, yields ended the month at around 4.16% and have risen some 30bp in just over a week. The main driver of the increase in the 10y nominal yield is real yields (i.e., not inflation). Exhibit #2 shows this phenomenon. The two lines that are practically sitting one on top of one another trace 10y nominal and 10y real yields (obviously on different axes). Movements in the nominal 10y are clearly due to movements in the real yield.

This begs the question what is driving real yields, especially considering that until Monday, fears of a U.S. recession had been increasing daily. Why would yields rise in such a situation, especially if inflation is not one of the factors? Last week (see here) we pointed out that short-term inflation expectations have clearly and understandably risen, thanks to the outlook for tariffs, but the longer-horizon expectations have remained remarkably stable. Indeed, with oil prices significantly weaker today than at the beginning of the year, long-run inflation expectations are truly – in Fed parlance – well anchored.

We think the answer to higher yields, then, lies in the third line on the chart, the term premium. It has risen to around +60bp (from below zero a year ago) in a pretty short period of time. With the fiscal package mentioned above still well short of passage, and the volatile policymaking and communication of April, we think the perceived riskiness of U.S. Treasurys has increased and indeed needs to rise (via higher term premia) to make bonds sufficiently attractive.

We also discussed the waning safe-haven appeal of USTs in recent months and showed evidence that higher-risk asset volatility has led to a counterintuitive increase in yields. In Exhibit #3, we show additional evidence of this development. The term premium on 10y USTs (black  line) is currently at its recent year high. In the past a spike in term premium has corresponded to cross-border inflows into the 7-10y portion of the UST curve. Note this feature is evident in the summer of 2022, November 2022, and November 2023. Rising premia lead to sufficiently cheap bond prices to induce overseas money back into the market. That behavior has ceased. Within the red rectangle, we see the term premium rise from under +30bp to approximately +60bp in just over a month. Yet foreign demand for this portion of the curve continues to fall, reversing the previous trend.

Forward look

To us, this suggests yields have further to rise – thanks to higher term premium acting on the real portion of the yield – before cross-border investors return in any meaningful way. To us a 10y note at over 4.5% is entirely likely in the short term, and if that’s not sufficient to attract overseas investors, the yield could go even higher. This also suggest that USTs’ lack of haven status in April was due to overseas investors not perceiving them as safe assets compared the Eurozone, Japan and other core sovereign markets which did see inflows. 

EXHIBIT #3: TERM PREMIUM NOT HIGH ENOUGH TO BUY

_{Source: BNY Markets, iFlow, Federal Reserve Bank of New York.} 

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