Key Highlights

• Treasury continues to lean on T-bill issuance to fund borrowing
• We think coupon increases will eventually have to follow 
• New York Fed President suggests ample reserves require balance sheet expansion

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Bill supply to be steady but still outpace coupon supply – could this change?

EXHIBIT #1: WHERE DOES THE T-BILL ISSUANCE GO?

_{Source: BNY Markets, US Treasury Department, Federal Reserve Board of Governors, Crane Data}

The U.S. Treasury Department lowered its borrowing estimate for the October-December quarter, thanks to a larger-than-anticipated Treasury General Account (TGA) cash balance reducing the overall financing requirement through the end of the year. Back in July, Treasury saw $590bn in net borrowing for the quarter, while it now sees just $569bn needed. The TGA had been tipped to stabilize at $850bn this quarter and next, but through the end of last week, it was more than $100bn above that level, at $953bn. A week earlier, it was slightly above $1tn.

Going into next year, Treasury expects to keep issuance of nominal coupons and floaters constant “for at least the next several quarters.” That means most of any increases in funding needs will fall on T-bill issuance, even though the Treasury Borrowing Advisory Committee (TBAC) warns that coupon issuance will need to be increased at least by 2027. We think it could come sooner than that, even though we are acutely aware of TBAC’s desire to lean on short-end issuance to fund government borrowing needs.

In Exhibit #1, we show that net T-bill issuance between the end of June (just before the Republican budget was passed) and the end of October was $809bn ($196bn in October alone). Of that sum, money market mutual funds (MMFs) bought approximately $730bn, according to our estimates. According to the Federal Reserve, reserves fell over the same approximate period by $514bn,  while the TGA increased by $593. In other words, almost all of the TGA increase has been reflected in lower system-wide reserves and has been financed primarily by bill issuance, much of which was financed by MMFs.

Earlier last week, we argued that demand for bills is relatively inelastic to supply (see here), and we still believe that to be true. We don’t think that market will get indigestion on a steady, robust diet of T-bill supply, but we do wonder if bills will be sufficient to finance all of the government’s borrowing needs or if coupon supply will have to increase as well. TBAC seems to think increases in note and bond issuance will be required in 2027, while we think it could come sooner than that.

Open market operations will be needed now that reserves are near ample

EXHIBIT #2: TGA GROWTH AND RESERVES DECLINE OFFSET EACH OTHER

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

We have been observing and commenting on the ongoing strains in funding markets since early September, and we were early when we called for the end of QT at the October FOMC (see here). Although money markets ended last week and began this week much calmer and in better shape than in previous weeks, we still see low and falling reserves as potentially problematic.Given the sensitivity of funding rates to lower reserves that we have observed recently (an indication that reserves have moved from an abundant state towards a merely ample one) , we think that open market operations will soon be on the agenda – likely not until early 2027, but potentially sooner – and the central bank will be compelled to gradually increase the size of the balance sheet to keep funding rates acceptably low.

In a speech delivered in Frankfurt, Germany last week, New York Fed President John Williams conceded as much when discussing the way forward for monetary policy operations and balance sheet policy. Once the central bank has assessed when reserves have indeed reached ample, “it will then be time to begin the process of assets that will maintain an ample level of reserves…”. Furthermore, Williams expects that “it will not be long before we reach ample reserves.” The implication is it will not be long before the balance sheet is actively used again to support the money markets.

We agree with Williams and said as much explicitly last week (see here). It seems that the Fed, including Chair Powell in his post-FOMC press conference the previous week is setting the table for open market operations as a means to manage interest rates in an ample reserves regime. This was not abnormal before the GFC, when the Fed was actually operating in a scarce reserves regime. Ample reserves would also require interventions in money markets during periods of funding stress. If the standing repo facility (SRF) continues to be more frequently used, it could forestall some of the need for direct open market operations, but if repos don’t suffice in keeping funding rates stable, expect the Fed to open itself to temporary open market operations (TOMOs).

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