February 4, 2025
Letter to the Secretary
Dear Mr. Secretary,
Congratulations on your appointment; we look forward to working with you. Since the TBAC last met in late October, 2-year Treasury yields are little changed while 10-year Treasury yields increased by about 25bp. The broad trade-weighted dollar appreciated 2.1% and is close to its high since 2022. Equity prices continued to advance with the S&P 500 up 4.0%. Interest rates and other asset prices have responded to the backdrop of robust growth and cooling, if still elevated, inflation, as well as to expected policies from the new Administration.
The rise in longer-term interest rates and dollar appreciation in part reflect continued strong growth in the US, which is exceptional relative to softer growth elsewhere. Economic activity has continued to advance at a solid pace with real GDP up 2.8% on average in 2024, supported by consumer spending. Business and housing investment, which are more sensitive to higher interest rates, also contributed to growth in 2024, but not as robustly.
Market concerns regarding downside risk to employment have diminished from their peak last September. After rising from a low of 3.4%, the unemployment rate stabilized at 4.1%-4.2% in the second half of 2024, and payroll job growth averaged 165k per month over the same period. The layoff rate is historically low at 1.1%, and initial claims for unemployment insurance are subdued. But the 3.3% hiring rate and 1.9% quit rate are below pre-pandemic norms, reflecting some softening of labor demand.
Various measures suggest inflation has significantly cooled but remains above the 2% target. Year-on-year core PCE inflation stood at 2.8% in December, but the three-month and six-month annualized paces have slowed to 2.2% and 2.3% respectively, suggesting year-on-year readings will fall in 2025. Market participants and Federal Reserve officials have been careful not to read too much into slower inflation in late 2024 as over the last two years inflation has accelerated in the first quarter.
After reducing policy rates by one percentage point in the second half of 2024, the Federal Open Market Committee (FOMC) signaled a slower pace of rate cuts. The median “dot” in the December Summary of Economic Projections (SEP) implies 50bp of cumulative rate cuts this year; since the December FOMC meeting, interest rate markets have priced-in between one and two 25bp rate cuts for 2025. Investors and Federal Reserve officials continue to debate whether and to what extent the long-term “neutral” policy rate has moved higher. Longer-term Treasury yields have remained elevated in part due to expectations that the US economy can continue to grow at rates at-or-above 2% with interest rates at higher levels than prevailed over the last 15 years.
Expectations regarding government policies are a key focus for the Treasury market and other markets. The Administration has indicated that it will pursue a fiscal package that will lower both taxes and spending and raise some new revenue through tariffs. The implied path of future deficits will affect Treasury issuance plans and therefore market interest rates. Markets will also remain sensitive to news on trade policy, with currency markets responding to which countries may be included in either targeted or across-the-board tariffs. Immigration policy and deregulation also affect the outlook for growth and inflation.
In light of this fiscal backdrop, the Committee reviewed Treasury’s February 2025 Quarterly Refunding Presentation. Based on the financing estimates published on February 3, Treasury currently expects privately-held net marketable borrowing of $815bln in Q2 FY 2025 (Q1 CY 2025), with an assumed end-of-March cash balance of $850bln. The borrowing estimate is $9bln lower than what was cited at the October 2024 refunding. For Q3 FY 2025 (Q2 CY 2025), privately-held net marketable borrowing is expected to be $123bln, with a cash balance of $850bln assumed at the end of June. These estimates assume enactment of a debt limit suspension or increase.
Since October, primary dealers revised their deficit estimates slightly higher over each of FY 2025, 2026, and 2027, in an aggregate amount of $188b. Committee members noted the varied interest rate assumptions used by primary dealers, the Office of Management and Budget, and the Congressional Budget Office. Some Committee members noted that some of these projections assume current law, which could contribute to elevated uncertainty around these forecasts.
Dealers now see the Federal Reserve’s balance sheet reduction ending in the summer, rather than the spring, slightly increasing the expected need for borrowing from the private sector in 2025. It was noted that market participants viewed risks as skewed towards a later finish (even as far out as Q1 CY 2026), or to a multi-step wind down of QT, as reserves are seen as ample. However, change in bank regulation and liquidity management relative to September 2019, compounded by potential debt limit dynamics into the early summer, may complicate the forward assessment of ample reserves, which could drive an earlier end date, all else equal.
The Committee then moved to discuss the first of two charges, an assessment of Treasury’s buyback program. The Committee found, and dealer feedback confirms, that the program is broadly meeting its stated objectives of liquidity support and cash management, and that there is no pressing need for change. While the program is small within the context of the overall size of the Treasury market, the take up in many individual operations can be significant. Notably, buybacks for nominal maturities less than 2 years and more than 10 years were more consistently filled than for those in the belly of the curve. While the program is still relatively nascent, this could represent either less need for liquidity in the belly of the curve, less willingness to sell, or both. Relative value analysis suggests that buyback operations effectively balance between relative value considerations and liquidity provisioning. Ultimately, the Committee noted the following areas for further study (both in the deck and in discussion):
- Study the results of the program at current capacity while thinking about how to adjust capacity as primary issuance sizes and sector composition change in the future.
- Consider whether the buyback schedule should take into account seasonality (e.g., around auctions) in off-the-run volumes, using Treasury volume data from TRACE.
- Discuss with dealers and study why demand for liquidity is concentrated in the longer-end and in short-end nominal coupons.
- Explore with dealers any areas that could make the program more effective.
- Study why TIPS buybacks have had uneven results. Investigate if liquidity operations for TIPS with maturities less than one year would be beneficial. Survey dealers regarding whether the complexity of valuation of TIPS makes assessing relative value difficult and operations less successful.
- Compare the Treasury program to previous Federal Reserve purchases to better understand trends in purchase operations.
The second charge related to the SEC central clearing rule adopted in December 2023 titled “Standards for Covered Clearing Agencies for U.S. Treasury Securities and Application of the Broker-Dealer Customer Protection Rule with Respect to U.S. Treasury Securities” (the Rule). The Rule represents the most significant change in Treasury market structure in decades, with as much as $4 trillion in additional daily transactions to be centrally cleared.
The Committee noted a variety of scoping and implementation issues that needed to be clarified or solved in order for market participants to move forward with implementation:
- Inter-affiliate requirements
- Mixed collateral tri-party repo
- Bank branch activity
- Cross border and jurisdictional application
While CME and ICE have indicated that they intend to file (or have filed) applications to offer Treasury clearing, there is currently a single central counterparty (CCP) in the Treasury market. Multiple clearing houses could be a positive development for competition, innovation, and access but also could raise issues regarding complexity, interoperability, and fragmentation. The potential for cross-margining across products and CCPs will be a significant factor in CCP adoption.
SIFMA and other industry associations have requested the implementations dates under the Rule be pushed back by a minimum of 12 months. The Committee noted that many market participants view an extension of the implementation dates as very likely.
In terms of issuance for the upcoming quarter, the Committee recommended that Treasury keep nominal coupon auction sizes unchanged. Turning to TIPS, the Committee supported increasing the 5y, 10y, and 30y TIPS auctions by $1bln. While the majority of the Committee supported increasing the size of the 30y TIPS auction, some members thought holding the current size steady would be preferred, citing a more limited buyer base and rising term premia.
In discussing issuance recommendations, the Committee uniformly encouraged Treasury to consider removing or modifying the forward guidance on nominal coupon and FRN auction sizes that has been in the refunding statement for the past four quarters. Some members preferred dropping the language altogether to reflect the uncertain outlook, though the majority preferred moderating the language at this meeting. Universally, the Committee felt that any shift in language should not be read to indicate an expected near-term increase in nominal coupon auction sizes, consistent with the TBAC recommended financing tables and Treasury’s objective to be regular and predictable. Members noted elevated uncertainty regarding macroeconomic developments and the fiscal trajectory and observed that current primary dealer assumptions and issuance levels imply a $1.5T cumulative funding shortfall over the next three years. As always, Treasury should maintain flexibility in future issuance decisions.
Away from economic events, the Committee emphasized the risk that debt limit constraints could hamper the efficient financing of the government at the lowest possible cost to the taxpayer. These episodes can cause significant economic uncertainty, affect financial markets, and impact US credit ratings. As noted in letters written both as part of the Quarterly Refunding process, but also independently in 2011, 2016, 2021, and 2023,[1] lack of resolution of the debt limit runs the risk of undermining the foundation of the US Treasury market.
Respectfully,
Deirdre K. Dunn
Chair, Treasury Borrowing Advisory Committee
Mohit Mittal
Vice Chair, Treasury Borrowing Advisory Committee