Large Treasury Bill Issuance Coming: What Investors Need to Know

In this article we review:

• The background behind the expected large issuance of U.S. Treasury bills that could exceed $1 trillion between now and year-end
• Why we believe this could result in a modest, but not material, increase in Treasury bill yields over the next few months
• How the market is likely to absorb this new supply without a dramatic impact to short-term rates
• How the Fed might be prepared to deal with any related liquidity impacts within the banking sector 

In the aftermath of the debt ceiling resolution, the U.S. Treasury Department is now preparing to fill a large backlog of Treasury bill issuance that could exceed $1 trillion. This has sparked concerns of rising interest rates at the short end of the curve and a potential liquidity crunch in the banking sector.

On June 7, the Treasury Department announced plans to increase its issuance of short-term bills to raise its depleted Treasury General Account (TGA), currently at approximately $50 billion, up to $425 billion by the end of June and $600 billion by the end of September. This will likely take place through a series of six-week auctions, ultimately ranking as the Treasury’s third-largest bill issuance ever, trailing only the issuances associated with the global financial crisis of 2008 and the initial onset of the COVID pandemic in 2020.

The first question at hand is whether the market can absorb this anticipated supply without a material rise in short-term interest rates and further yield-curve inversion. In this regard, it is our judgment, all else being equal, that the Treasury bill market could see some modest upward pressure on rates from this issuance in the months ahead, perhaps about 0.2%. This, of course, would need to be considered along with various other factors impacting short-term rates during this time frame. 

We make this judgment based on the following points:

• A potentially large source to help absorb the upcoming supply of bills is Government Money Market Funds (MMF), now estimated at approximately $4.5 trillion in aggregate assets. Due to a lack of recent Treasury Bill issuance, these funds have been invested heavily in the Federal Reserve’s overnight reverse repurchase agreement (“Fed repo” or “ON RRP”) now exceeding $2 trillion. Therefore, it is probable that modest Treasury bill yield premiums to the Fed’s current ON RRP rate of 5.05% could attract a good portion of this asset base. The 3-month U.S. Treasury bill yield closed on June 9 at 5.27%. 
   
• Currently Government MMFs are invested at historically low percentages of Treasury Bills and historically high percentages of Fed repos. If MMFs in total were to increase their Treasury bill holdings to pre-pandemic weightings, perhaps about 6% or so higher than current levels, that alone could cover about one-third of the expected supply and likely stem off any abnormally high market-induced rise in yields.
   
• As a basis of comparison, during the onset of the COVID crisis, when Treasury bill issuance increased approximately $2.5 trillion over the three months of April–July 2020, the yield spread between Treasury bills and the Secured Overnight Funding Rate (SOFR) increased to as high as 0.25% in the first month before settling in the following two months in the 0.10–0.15% range. Under those assumptions, 3-month Treasury bills have, for the most part, already priced in such a spread (5.27% vs. 5.05% as of June 9). However, circumstances are a good bit different in the present market environment.
   
• At the forefront of those differences is the Fed’s current restrictive mode versus their accommodative stance back in 2020. Back then, the fed funds rate had been cut to zero and the Fed was purchasing record amounts of Treasury bonds at a monthly pace of $80 billion as part of its unprecedented quantitative easing policy and balance sheet expansion. In contrast, current market expectations are that the Fed could continue raising interest rates above the present fed funds target range of 5.0–5.25% while also maintaining its quantitative tightening balance sheet reduction plan of rolling off $60 billion monthly in Treasury securities.
   
• Markets are clearly now facing a set of variables without much precedence nor lending themselves to high predictability. However, given all these factors, our best estimate is, all else being equal, that Treasury bill spreads to the Fed’s repo rate could widen an incremental 0.2% or so between now and year-end. Assuming no further rate hikes from the Fed, this would infer a 3-month Treasury bill yield of approximately 5.45% versus a fed funds rate lower bound of 5% and a Fed repo rate of 5.05%.  
   
• When considering the prospect of another rate hike by the Fed perhaps in July, this would infer a 3-month Treasury bill yield of approximately 5.7% versus a lower bound fed funds rate of 5.25% and a Fed repo rate of 5.3%. This could also result in further inverting of the yield curve for Treasury Bills versus the 2-year Treasury yield for a few months before returning to current differentials soon thereafter. However, we caution there are several other potential factors that could exacerbate, neutralize, or even negate this move, which could include changing economic conditions and the Fed’s response to them as well as a reversion in Treasury bill yields after the new issuance has been absorbed by the market. 
   
• There has also been some market concern the expected Treasury bill issuance could result in another round of bank deposit withdrawals, once again creating further liquidity concerns in the banking sector and the economic impacts that could follow. Should the upcoming Treasury bill issuance be sufficiently absorbed, this is unlikely to be a major risk. In the event bank depositors do exit accounts on a wide scale for higher bill yields, the Fed could act quickly to mitigate such risk, similar to how it did back in March, through actions ranging from overall policy decisions, adjusting the repo rate, curtailing balance sheet reduction, or expanding provisions within the Bank Term Funding Program.                         

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