Letter to the Secretary
Dear Mr. Secretary,
After a period of heightened market volatility in early April, financial markets have stabilized over the last three months, reflecting increasing comfort regarding the outlook for the US and global economy. The S&P 500 index recovered from sharp declines in early April and is now up more than 8% since the start of the year following progress on trade agreements. Treasury yields have been relatively stable over the last three months, with ten-year Treasury yields in a range around 4.4% and two-year Treasury yields averaging about 3.9%. After a more rapid depreciation in early April, the broad trade-weighted US dollar has continued to weaken, but at a slower rate, totaling an 8% depreciation over the course of the year. Measures of implied asset price volatility that had been elevated have fallen back to low levels.
During the last three months markets have remained orderly and liquid. Stable financing rates in the repo market and a well-behaved cross currency basis suggest that liquidity remains ample in US funding markets. Some members highlighted the potential that a rapid increase in bill issuance in conjunction with lower levels for RRP and uncertainty around levels of ample reserves could create funding stress as we head into the Treasury’s 2025 fiscal year end.
The balance between supply and demand for US Treasuries remains a key focus for investors both domestically and abroad. Deficits are projected to grow to just over $2 trillion in FY 2027. The enactment of the One Big Beautiful Bill Act (OBBBA) did not significantly affect Treasury yields, indicating its implications for the deficit were close to market expectations. OBBBA raised the statutory debt limit by $5 trillion, removing near-term debt limit concerns. Fiscal projections are now incorporating significant new revenue from increased tariff collections. Treasury auction results have received increased market attention in the last several months. Overall, demand at auctions remains robust with bid-to-cover ratios in normal ranges. Guidance from Treasury regarding the potential timing of any increases in coupon auction sizes also is receiving attention.
One way of assessing the Treasury supply-demand balance is by tracking the spread between yields on Treasury securities and like-maturity SOFR swaps. Over the last three and a half years, Treasuries have cheapened relative to swaps: the Treasury – SOFR spread at the ten-year maturity has declined from -20bp at the end of 2021 to -53bp currently. In early April, Treasury securities rapidly cheapened relative to swaps but since the last TBAC meeting the spread between interest rates on Treasuries and derivatives has been stable.
The GENIUS Act, which establishes a legal framework for issuing stablecoins, was signed into law on July 18th. Under the Act, stablecoins must be backed on a 1 to 1 basis by reserves comprising cash, deposits, repurchase agreements, or Treasury bills, notes, or bonds with a remaining maturity of 93 days or less (or money market funds which hold the same assets). As discussed in detail at the previous TBAC meeting,[1] increased stablecoin issuance could create a new source of demand for short-maturity Treasury securities. While this might be offset by a reduction in demand from traditional Treasury investors if stablecoins act as a substitute for deposits, money market funds, or other cash-like instruments, much of the Committee seemed more optimistic about this as a source of new demand for T-bills. Potential impact to bank deposits bears close monitoring.
The timing and extent of pass-through of tariff costs to consumer prices remains highly uncertain. In data through June there were some limited signs of larger than usual price increases for certain goods. It may be that consumer prices will rise further over time as firms work through existing inventories, as price increases are passed from one phase of production to the next, or simply as previously contracted prices are updated. It may also be the case that there is only limited pass-through to consumer prices as domestic firms absorb tariff costs by compressing profit margins or foreign exporters reduce their prices to absorb the tariffs. Some members suggested that policymakers may look through a one-time price adjustment. This has increased market focus on the full range of price data, including producer and import price indices.
After reducing policy rates by one percentage point in the second half of 2024, the Federal Open Market Committee (FOMC) paused rate cuts. Many officials have emphasized that waiting gives the FOMC time to assess upside risk to inflation from tariffs. Chair Powell suggested that data “over the summer” would help Fed officials make a decision regarding resuming rate cuts. In the June Summary of Economic Projections (SEP), the median Fed official advocated 50bp of rate cuts this year. Consistent with this guidance, interest rate markets are pricing about 17bp of cuts for September and 45bp for the year. Another 70bp of cuts are priced for next year, with markets anticipating a terminal policy rate just over 3%. The Committee felt strongly that independence of the FOMC remains of paramount importance to a healthy and well-functioning Treasury market with widespread investor demand.
Since April, primary dealers’ deficit estimates were virtually unchanged over the course of FY 2025, 2026, and 2027, declining by an aggregate amount of $14bn. Primary dealers noted significant uncertainty in their outlooks, as tariff deals continue to be finalized, and resulting revenue as well as the pass-through to the consumer and corporate tax earnings is uncertain. Additionally, many Committee members highlighted the potential for variation in immigration policy to drive changes in labor statistics.
The Committee then moved to discuss the charge for the quarter, which focused on potential enhancements to Treasury’s buyback program. The program was universally acknowledged as working well, and the Committee spent most of the discussion debating the capacity for increasing the program, and a quantitative framework to help inform any sectoral changes.
The Committee focused primarily on liquidity support buybacks, noting that Treasury’s cashflow projections likely take priority in informing appropriate sizing for the cash management buybacks. In considering recommendations to increase the liquidity support buybacks, the Committee focused heavily on Treasury’s stated objective: liquidity support buybacks are not intended to change the overall maturity profile of debt outstanding. In order to quantify that, the Committee reviewed the 3y standard deviations of annual changes in WAM (2 months across all environments, 1 month across non-recessionary environments). The Committee noted that the current program, if executed fully at maximum sizes offered, shortens WAM by 0.4 months per year – well within the typical 1y change. The Committee felt that there was therefore capacity to double the program, if appropriate, without materially impacting WAM.
The Committee then discussed a quantitative framework to augment other considerations with respect to Treasury’s decisions on sizing offered across various sectors. Specifically, the group felt that the 10y-20y and 20-30y sectors could benefit from increased sizing, based on a combination of several metrics.
There was some debate among Committee members as to whether concentrating an increase in liquidity support buybacks in certain sectors of the curve could be misconstrued as WAM management, and for that reason many members felt a uniform increase across the curve, even though take up might routinely be below capacity, would be preferable. The majority of the Committee felt that they would be more comfortable recommending larger increases, or sectoral specific increases, if there was a more directly visible incorporation of the buyback program related funding needs into Treasury’s overall issuance decision.
There was some discussion as to when weakness in certain sectors, as evidenced by the presenting member’s buyback score, warranted a buyback adjustment versus an issuance reconsideration. Regardless, the Committee felt that communication to the market was critical to ensure the program was not misconstrued to be active WAM management. Overall, the Committee felt there was scope to make the program larger and more responsive to evolving market conditions, while still being regular and predictable. However, it would be critical that Treasury monitor and adapt to any material buyback-driven change in debt distribution. The Committee feels strongly that issuance is the primary tool for managing the debt profile.
In addition to operation size and tenor, the Committee discussed potential enhancements to the execution process for liquidity support buybacks. While the option to execute buybacks on swap vs the on-the-run could be marginally beneficial, it would likely present an operational hurdle. There was more support from the group and also from the primary dealer community for yield spread execution. While the view wasn’t uniform, many Committee members felt that expanding the counterparty list could also both improve the impact of the program and provide Treasury with additional information.
In discussing this year’s increase in term premium and the consequences for issuance, it was noted that a previous TBAC study in Q3 2023[2] had analyzed the optimal debt structure under different term premium scenarios. That charge demonstrated that the issuance distribution at that point in time would likely be appropriate even with a modest increase in term premium (assuming a static level of deficits). Over the past 27 months, deficits and deficit uncertainty have increased; term premium has increased modestly more than the scenarios considered, suggesting that a refresh of the optimal debt structure analysis could be beneficial. Additionally, the Committee discussed the fact that evolution in demand patterns suggests increased demand in front end and intermediate maturities relative to reduced demand in longer end maturities.
In terms of issuance, the Committee recommended keeping nominal coupon sizes unchanged, and that the 5-year TIPS be increased by $1bn in October 2025. The Committee discussed potential changes to coupon issuance in the future, and the timing thereof. Given the breadth of uncertainty relating to both receipts and expenditures, the Committee was mixed on whether adjustment to Treasury’s expressed expectations of future changes was necessary.
Respectfully,
Deirdre K. Dunn
Chair, Treasury Borrowing Advisory Committee
Mohit Mittal
Vice Chair, Treasury Borrowing Advisory Committee