Key Highlights

• Bill supply is set to increase – but upward pressure on SOFR somewhat capped
• Rate expectations to moderate further, helping keep SOFR contained
• New-look FOMC minutes offer first read on Warsh’s communication style

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Bill supply and SOFR

EXHIBIT #1: TERM SOFR TIGHTER RECENTLY

_{Source: BNY Markets, Bloomberg}

EXHIBIT #2:  MORE T-BILL SUPPLY COMING THIS SUMMER

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

Increased T-bill supply for coming months has been identified as a driver for higher SOFR rates going forward, but we think there’s a mitigating factor if the market continues to price out the most hawkish of expectations for the FOMC for the rest of 2026. As can be seen in Exhibit 1, the 3m term SOFR spread of the 3m T-bill rate has nearly halved since the post-June FOMC pop in hawkish pricing. We think that moderation in the labor data and short-term relief in consumer prices can keep these spreads from widening much further.

Net bill issuance between July and September has averaged nearly $500bn over the past three years, while issuance in the April to June period has been negative by about $90bn. Given the dim chances for significant coupon issuance in coming quarters – according to Treasury guidance this past May – it’s likely that Treasury’s borrowing needs will require additional boosts to bill auctions over the next several months. Exhibit 2 shows average monthly T-bill issuance starting in 2022. The evolution of supply so far this year is in line with those of the first half of recent years, and we suspect the next few months will resemble the same period from previous years.

Will this push SOFR rates even higher, as many have argued? As mentioned above, we think that Fed expectations could soften, probably having reached peak hawkishness right after Kevin Warsh’s first FOMC meeting as Chair. See the Rates outlook below for the latest on our monetary policy views. The spread between 6m and 3m term SOFR had widened as well, with increasing expectations of higher rates since the commencement of the U.S.–Iran conflict, but since the last FOMC this spread is now flat.

The real question over the next few months, as expected T-bill issuance increases, is whether or not it can be comfortably absorbed by the market. There has been some reluctance by money market mutual funds (MMFs) to move out the curve and increase weighted average maturity, given still-present expectations of a rate hike, and this might have impacted demand for recent auctions.

In addition, the Fed has been scaling back the size of its reserve management purchases (RMPs) since the April tax month, although it still is buying bills with asset-backed securities and coupon proceeds. Reserves are actually some $160bn lower now than they were on April 15, but there are still scant signs of funding market volatility. Bill issuance, and the impact it has on the Treasury General Account (TGA) and reserves, is probably the biggest short-term driver of changes in the liability side of the Fed’s balance sheet. With increased issuance and a higher TGA, stress could show up in general collateral markets.

EXHIBIT #3: BILL SUPPLY MEETS REAL MONEY BILL DEMAND

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

However, with MMFs continuing to post record AUMs and cash preferences, we don’t think the expected ramp up in supply will have too much trouble finding buys, especially if Fed rate expectations come in lower – a data driven process we’ll be watching. Exhibit 3 shows that based on iFlow data, real money demand for T-bills is nearly inelastic, a robust result that held before, during and after the pandemic. We would be wary that any spread widening will be long-lived and expect the market to absorb increased supply. 

Will the Minutes become more minute?

During an otherwise quiet data week, the FOMC will release the minutes for the June meeting, Warsh’s first. Historically, FOMC minutes releases rarely move markets: the language is balanced to the point of blandness, and by the time they are released, post-meeting communications have already shaped market expectations, leaving them looking stale. This time around, the minutes are likely to look much different, now bearing Warsh’s imprint.

Ironically, even if the text itself is even more parsimonious and sterile than usual, the Fed’s shift toward a more restrained communication style could make these minutes more market-relevant, given that we did NOT get the typical raft of post-meeting Fedspeak. At the very least, they are likely to be more heavily scrutinized than minutes typically are.

On balance, the minutes may not actually be overtly dovish, but the absence of much hawkishness on the other side of the debate could catch a market that’s already leaning hawkish by surprise. It’s less about the minutes themselves than how they could be perceived relative to current thinking.

Until markets fully calibrate to the new, more spartan communication style, we believe there’s a risk the absence of clear communication will be interpreted as a rejection of the Fed’s current market view, whatever that view is today. We saw a version of this last week at the ECB’s annual conference in Sintra, Portugal, where Warsh’s appearance was interpreted as dovish, even though, to our ears, he said very little of substance. But because expectations had been set for a hawkish message, his reticence was treated as a meaningful deviation.

While markets will parse the minutes for clues about the Fed’s reaction function, we’ll be watching for clues about the markets’.

Rates outlook

There is no change to our rates outlook this week. The June payrolls report was moderate relative to market expectations and represented a meaningful slowing from the previous three months’ reports. Nevertheless, the unemployment rate did decline from 4.4% to 4.2%, primarily due to a smaller labor force last month. We won’t overinterpret the results, given the large revisions that typically occur in subsequent publications and the fact that the report only represents one month of noisy data. Still, the release blunted some of hawkish expectations, and we think inflation could start to show month-to-month relief, with lower energy prices, adding to the receding hawkish tilt currently present in markets.

This week offers little meaningful data – with the exception of the June FOMC minutes mentioned above – so we don’t expect economic developments to lead to large market swings. July rate hike expectations are almost completely faded in the futures market, down to just around 25% probability, compared to around 40% just after last month’s meeting. 

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