U.S. Department of the Treasury

April 29, 2025

Letter to the Secretary 

Dear Mr. Secretary,  

Since the TBAC last met in early February, changes in US government policy and shifting economic projections, most notably higher-than-expected tariff rates, have led to significant movements across global asset markets. 

_{*Source: Bloomberg
*Treasury yields are in %, "Current" is April 28th for Treasury yields and the S&P 500. "Current" is April 25th for the USD due to a reporting lag.
*USD is the nominal broad trade weighted dollar as calculated by the Board of Governors of the Federal Reserve System.}

While shifts in the fiscal and economic outlook have driven much of these moves, market volatility and resulting investor response (whether realized or simply anticipated) has also played a significant role in the repricing. While it can be hard to cleanly delineate the relative contributions of the two factors, the Committee hopes that our collective market expertise provides useful insight as we look to the future. 

The global economic outlook is now among the most uncertain in recent memory. While currently available US data show a slowing but still resilient economy, the outlook is currently dominated by international trade negotiations and associated economic impact. Economic forecasters have significantly marked down their projections for growth and marked up their projections for unemployment and inflation. The median forecast for 2025 real GDP growth as captured by Bloomberg fell from 2.2% to 1.4%, the projected unemployment rate in Q4 2025 increased from 4.3% to 4.6% and Q4/Q4 core PCE inflation increased from 2.5% to 3.2%. Markets reflect a much higher probability that the Federal Reserve will cut rates significantly this year.

Inflation remains elevated with core PCE at 2.8%YoY in February. Readings in January and February were annualized to 3.6% and 4.5% respectively, but softer PPI and CPI suggest core PCE will resume a slowing trend in March. Market participants and Federal Reserve officials are likely to increasingly separate goods inflation – which should be directly affected by tariffs – and services inflation. 

As expected, therefore, some surveys show a significant increase in consumer inflation expectations. The University of Michigan Survey of Consumers 1-year inflation expectation rose to 6.5% in April and the 5-to 10-year expectation increased to 4.4%. But other surveys are less concerning. For instance, the March Federal Reserve Bank of New York Survey of Consumer Expectations shows a 1-year inflation expectation of 3.6% and the 5-year ahead expectation at 2.9%, within the range that has prevailed since 2023. Market-based break-even inflation is unchanged or lower since higher tariffs were announced, but that may be due to a rise in real yields as investors prefer the higher liquidity of nominal Treasuries in a volatile market environment. 

Projecting funding needs (in addition to economic outlook) is especially challenging ahead of a visible end state on international trade negotiations. After reducing policy rates by one percentage point in the second half of 2024, the Federal Open Market Committee (FOMC) paused rate cuts in January and March and is signaling that pause will continue at least through the May FOMC meeting. Given upside risks to inflation, downside risks to the labor market, and continued policy uncertainty, most Federal Reserve officials have indicated that they prefer to wait for more clarity on policy and the economy before adjusting policy rates. Interest rate markets are currently pricing about 90bp of rate cuts this year. This indicates that relative to the Federal Reserve dot-plot median for two rate cuts this year, market participants see risks as skewed to scenarios where the Federal Reserve would cut more deeply. The implication being that should the labor market deteriorate, Federal Reserve officials would be prepared to “look-through” tariff-related inflation and reduce policy rates to support the labor market. 

While most attention has centered on trade policy, Treasury investors are also monitoring fiscal developments. With a compromise budget resolution passed by the House and Senate, interest rate markets will be sensitive to deficit implications of the details of the fiscal package and look forward to debt limit resolution. Assumptions about future tariff revenue also affect projections for future deficits and Treasury supply. Market participants are questioning a credible path to a more balanced deficit outlook over the medium term, contributing to the rise in term premium.

Heightened economic uncertainty has hampered risk taking and warranted increased return for risk warehousing.

More significant than the net market moves, however, has been the scale of intraday volatility. From April 1 to April 28^th, the 10yr rallied 5bps. However, the peak to trough intraday moves add up to a cumulatively traversed 184bp of yield change, highlighting the challenging risk environment for investors.

Despite the volatility of the move, the rise in longer term yields in Treasuries was, for the most part, orderly. Weak demand at the April 8^th 3-year auction did drive a further rise in longer-term Treasury yields, but a series of solid auction results with robust foreign allotment subsequently helped assuage investor concerns.

More broadly, the highly unusual simultaneous decline in valuations for US equities, Treasuries, and the US dollar drove some investors to question the “safe haven” status of US Treasuries, and in some instances even the status of the USD as the world’s reserve currency. The spread between 10-year Treasury yields and like-maturity SOFR swaps rapidly fell from -44bp to -60bp, before stabilizing at -51bp. This cheapening of cash Treasuries relative to derivatives was accompanied by an increase in term premium, a surge in gold prices, a breakdown in real versus nominal yields, widening of bid-offer spreads, and many other signs of significant stress. As in any VaR shock, investors reduced exposure, though in this episode, US Treasuries were not the safe haven investors typically seek in times of uncertainty. Contributing factors include:

• Uncertainty about the US economic and fiscal outlook
• Fears of long-term investor selling of US Treasuries and US assets
• Deleveraging in response to the VaR shock 
• Views that an adjustment of global trade balances would lead to lower demand for US assets
• Unpredictability of announcements and tariff updates constraining risk capacity
• Concerns about any threat to the independence of the Federal Reserve
   

Any one of these factors is significant enough to disrupt risk transfer in markets, and the US Treasury market was no exception. Notably, the funding markets remained remarkably stable throughout the volatility. The cost of financing Treasury securities in the repurchase market was largely stable. The basis between Treasury securities and futures contracts and the basis between on-the-run and off-the-run Treasuries were steady. The Committee noted that the level of abundant reserves in the system likely helped ease the potential disruption during this period of market volatility, which also coincided with the April 15 remittances. Funding stability played a critical role in the US Treasury market’s ability to function through the broader economic uncertainty and market volatility.

While the US Treasury market functioned well through the extreme volatility, and market functioning has largely returned to normal, these concerns remain a contributing factor in investor risk decisions. The Committee feels these concerns are unlikely to abate given ongoing tariff negotiations and elevated economic uncertainty. Additionally, the Committee feels there is an incremental risk premium in the US Treasury market now due to unusually high headline risk which creates incremental cost to the taxpayer and impacts market participants’ confidence in owning and intermediating US Treasuries.

Treasury’s buyback program remained well received by the market through this period, in keeping with its objectives to support liquidity and cash management. The Committee felt there is scope to continue to evolve the program, in line with these stated goals. However, the Committee felt it important that broader metrics such as WAM still be managed through Treasury’s issuance decisions.

In light of this backdrop, the Committee reviewed Treasury’s May 2025 Quarterly Refunding Presentation. Based on the estimates published on April 28^th, Treasury currently expects privately-held net marketable borrowing of $514bln in Q3 FY 2025 (Q2 CY 2025) with an assumed end-of-June cash balance of $850bln. For Q4 FY 2025 (Q3 CY 2025), privately-held net marketable borrowing is expected to be $554bln, with a cash balance of $850bln projected at the end of September. These estimates assume enactment of a debt limit suspension or increase.

Since January, primary dealers revised their deficit estimates slightly lower over the course of FY 2025, 2026, and 2027, by an aggregate amount of $13bn. Primary dealers noted significant uncertainty in their outlooks, given current market events. 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.

The Committee’s first charge focused on the debt limit, with a discussion on the conclusions of the December 2024 GAO report. The Committee felt strongly that, in practice, the debt limit does very little to constrain spending, so the benefit of it is unclear. On the contrary, the Committee highlighted many known negative impacts of the current debt limit process, including:

• Increased volatility in TGA balances, reserves, and T-bill issuance 
• Increased debt servicing cost
• Negative impact on the US credit rating
• Negative impact on US reserve status and possible impact on UST demand
• Increased risk of technical default
• Waste of resources in the public and private sectors

The GAO report lays out three options to improve the process: 1. Linking the debt limit to the budget process, 2. Providing the administration with the authority to increase the limit, subject to Congressional motion of disapproval, and 3. Abolishing the debt limit.

While the Committee uniformly felt that the debt limit provides no constraint on spending, and felt this was largely understood by most market participants, there was some acknowledgement that an abolishment of the debt limit could raise perception questions about future spending. Investors could be more sensitive to those questions in the current market environment. However, as the debt limit provides no practical limitation to spending, but does introduce meaningful known risks, the Committee concluded that the best option was eliminating the debt limit altogether. The Committee felt market perception risk around fiscal responsibility could be managed in other ways, and eliminating the current challenges, and most importantly, the risk of an inadvertent technical default would far outweigh any concerns. This is consistent with the Committee’s longstanding feedback and letters in previous debt limit episodes. The long-run benefits of reducing market disruption around debt limit episodes would reduce risks to the financial system and likely decrease costs to the taxpayers.

The second charge focused on stablecoins and their intersection with the US Treasury market. The current market cap of stablecoins is around $234bn, with roughly half of that currently reported as invested in T-bills, with another $90bn in money market funds. The Committee noted that evolving market dynamics and proposed legislation have caused some estimates of the growth trajectory of stablecoins to reach ~$2tn in market cap by 2028. 

The Committee discussed the potential impact to US Treasury demand. Legislation design is likely to determine both scale of growth in the industry and sources of inflows (e.g., unbanked users, reallocations from money market funds, or reallocations from bank deposits). Growth in stablecoins from unbanked market segments would be positive for T-bill demand, while growth at the expense of money market funds would likely be neutral. Committee members worry that growth at the expense of bank deposits could impact credit creation and the existing demand profile for US Treasury securities from the banking sector.

Additionally, the question of interest-bearing stablecoins warrants careful consideration. Current draft legislation precludes stablecoins from paying interest. The Committee expressed concerns about interest-bearing stablecoins and felt that further study was warranted, as was further regulatory environment design.

In terms of issuance, the Committee recommended keeping nominal coupon sizes unchanged, and that the 5-year and 10-year TIPS be increased by $1bn each. The Committee briefly discussed the current demand dynamics for TIPS, especially in light of tariff-driven uncertainty in inflation. As the debt stock continues to grow, the Committee felt a review of percentage share-based guidance could be appropriate.

While the Committee recommended no change to nominal auction sizes in the next several quarters, members were mixed on the value of the forward guidance language. Some members preferred dropping the language altogether, while others felt a shift in the language might be received poorly in light of the meaningful increase in uncertainty around tariffs and the economic outlook. 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 stated objective to be regular and predictable. As always, and even more importantly in uncertain times, Treasury maintains flexibility in future issuance decisions.

Lastly, away from economic events, the risk that debt limit constraints could hamper the efficient funding of the government at the lowest possible cost to the taxpayer remains a primary concern of the Committee and the market. 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, 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