February 3, 2026
Letter to the Secretary
Dear Mr. Secretary,
Since the TBAC last met in early November, Treasury yields are little changed. While domestic fixed-income markets were relatively stable, a sharp rise in Japan government bond yields in January rippled through global fixed-income markets. Equity prices continued to advance over the last three months, and the S&P 500 is now up 16% over the last year. Credit spreads remain tight. The VIX measure of implied volatility, at 16, is close to multi-year lows. Three-month expiry options on ten-year interest rate swaps imply just 66 basis points (bp) of annualized volatility, also a historically low reading.
Currency and commodity prices have exhibited higher volatility. The US dollar depreciated sharply against major currencies in late January, but that move partially reversed in recent days. Gold and silver prices have risen significantly – over the last year gold is up 67%. Prices for precious metals increased during the late-January dollar depreciation but fell sharply as the US dollar strengthened in recent days. The recent decline in precious metals prices may have been exacerbated by changes in margin requirements. Copper prices have followed their own path higher and are up 21% over the last three months. Oil prices rose modestly in January, in part reacting to geopolitical tensions.
Economic data releases were substantially delayed, and in some cases distorted, by the government shutdown in October and November 2025. Most notable was the inability of the Bureau of Labor Statistics (BLS) to produce an October CPI inflation report. Measures of inflation were distorted lower as the BLS assumed that some prices were unchanged between September and October in the absence of data. Shelter inflation was effectively assumed to be zero in the month of October, likely resulting in a stronger reading come April. This is now well understood by market participants and a stronger April inflation reading will not come as a surprise.
In Q4 2025, upward pressure on short-term interest rates suggested reserve balances might be falling below levels consistent with the Fed’s desire to provide “ample” liquidity. Usage of the Fed’s Standing Repo Operation increased, though repo rates still exceeded the upper bound of the Fed Funds policy rate at times. Balance sheet reduction ended on December 1st and the Fed began buying $40 billion per month of Treasury bills, via “Reserve Management Purchases” (RMPs), on December 12th. These RMPs modestly grow the Fed’s balance sheet to help maintain an ample level of reserves and do not significantly affect longer-maturity yields.
In early January, President Trump indicated that his Administration intends to reduce costs for new homebuyers by bringing down mortgage rates, and as such that Fannie Mae and Freddie Mac would purchase $200 billion of mortgage-backed securities. This is a relatively small share of total MBS outstanding, but a meaningful share of expected net supply in 2026. Some investors viewed the development as signal that government institutions may take a more active role in keeping fixed-income yields in general, and mortgage rates in particular, lower.
After delivering 25bp rate cuts at the last three FOMC meetings of 2025, Fed officials left policy rates unchanged in January. Chair Powell continued to guide toward potential further cuts should inflation slow further or labor markets loosen. Markets are aligned with this guidance, implying slightly less than 50 bps of rate cuts this year. Markets were little changed after President Trump announced he would nominate Kevin Warsh to be Fed Chair following the expiration of Chair Powell’s term in May.
Real activity expanded strongly in 2025, with most forecasters and Fed officials expecting a continued expansion this year. Consumer spending has remained solid and is expected to be supported in Q1 2026 by larger tax refunds associated with last year’s One Big Beautiful Bill Act. Business investment has been supported by capital spending on electronics, consistent with corporate commitments to grow investments related to artificial intelligence. The housing sector remains weak as a consequence of elevated prices and mortgage rates, with single-family housing starts and permits falling in recent months.
The pace of job growth has slowed more significantly than other measures of economic activity. In the last three months of 2025, additions to private nonfarm payrolls averaged just 29,000 per month. The unemployment rate has remained relatively stable at 4.4% in recent months, suggesting that the “breakeven” pace of job growth required to keep the unemployment rate from rising has declined substantially due to reduced immigration flows and slower labor force growth. Other signs point to a still gradually loosening labor market. For instance, the number of individuals who report jobs as “hard to get” in the Conference Board’s consumer survey continues to increase.
Inflation remains elevated, with core PCE at 2.8% year over year in November. Goods price inflation has remained elevated as firms pass through tariff-related cost increases. Services inflation has slowed due to cooling shelter prices. Rising commodity prices present a new upside risk to inflation. Survey and market-based measures of inflation expectations are stable and consistent with inflation returning to target.
The balance between supply and demand for US Treasury securities remains a key focus for investors both domestically and abroad. The level of tariff revenue has become an important input into deficit projections, and markets are focused on how an upcoming Supreme Court decision related to International Emergency Economic Powers Act tariffs could affect future revenue. 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 is also receiving attention.
In light of that backdrop, the Committee moved to review the quarter’s receipts and outlays, as well as the primary dealer feedback. Notably, the Committee supported Treasury’s efforts to explore the viability of a Secured Overnight Financing Rate (SOFR) Floating Rate Note (FRN) and echoed the results of Treasury’s primary dealer survey, where the majority of dealers supported exploring issuance. When considering money market mutual fund (MMF) interest, the group focused on weighing cannibalization of existing Treasury bill demand versus the value of introducing investment products that would facilitate management of weighted average maturity by MMFs and may help incrementally grow MMF balances. Most Committee members were of the view that net investment portfolios of non-financial corporates, high-net-worth individuals, and Treasury-only MMFs could absorb additional FRN issuance. When considering potential bank appetite for the product, the Committee deliberated the relative advantage of a SOFR FRN compared to other Treasury securities on asset swap. There was broad agreement that a SOFR FRN was likely more desirable from a margin, accounting, and operational perspective, especially for smaller banks.
The Committee moved to discuss the first charge, which focused on how Treasury should consider the composition of privately-held Treasury securities compared to total Treasury debt outstanding, including the holdings of the Federal Reserve’s System Open Market Account (SOMA), when evaluating its issuance mix.
The presenting member revisited the concept of the consolidated government balance sheet presented in the February 2020 charge. Treasury securities in the SOMA portfolio are offsetting liabilities of the Treasury and assets of the Fed. As a result, the liability side of the consolidated balance sheet consists of only those Treasury securities which are privately held. On the consolidated balance sheet, the SOMA portfolio can be thought of as effectively converting some Treasury securities into a perpetual zero-coupon liability (the component supporting currency in circulation, which pays no interest and has no obvious maturity), and converting other Treasury securities and mortgage backed securities (MBS) into overnight floating interest rate bearing liabilities (such as bank reserves and overnight Reverse Repo Program (ON RRP). While before the Great Financial Crisis (GFC) nearly all the SOMA portfolio was held against currency in circulation, nearly half of the SOMA portfolio is presently held against reserves and other interest-bearing liabilities, meaning the income of the Federal Reserve is more sensitive to an increase in interest rates.
The Committee was in broad agreement that Federal Reserve policy inflection points are relevant times to consider the composition of privately held Treasury securities when making issuance decisions. The rate of change of the difference between the Consolidated Weighted Median Next Rate Reset (WMNRR) and the total WMNRR can be used as an indicator of relevant timing for this consideration. The Fed has a recent history of meaningful Quantitative Easing (QE) actions over short periods of time, the effects of which Treasury could consider in due course. QE that has run its policy course changes the composition of private holdings. Treasury may find that it can make cost- and risk-efficient adjustments to its issuance mix due to the resulting changes in supply and demand, within its ever-important “regular and predictable” framework. Present day considerations include increased demand for Treasury bills as part of Federal Reserve MBS run-off reinvestments and RMPs. The separation of mandates for the Treasury and Fed is important, but it is well understood that there can be cross effects; Treasury could factor in the impact of these effects on privately-held Treasury balances when it evaluates its issuance mix.
The Committee then moved onto the second charge, reviewing trends in investor demand for Treasury securities. The presenting member noted the shift in Treasury holdings since 2022 from the Federal Reserve’s SOMA portfolio to more price sensitive investors. These include a broad range of other investors including MMFs, exchange-traded funds, banks, and broker-dealers. While foreign investors continue to be the largest holders of Treasury securities in aggregate, nearly all of the growth in foreign demand in recent years has come from the private sector.
When considering pension and insurance demand, the presenting member noted pensions shifting away from defined benefit (DB) funds in favor of defined contribution (DC) funds, perhaps hampering aggregate demand from the sector. However, looking forward, demographics may be more supportive in the future, given the increasingly concentrated household wealth in higher age cohorts, who have higher fixed-income allocations. A potential increase in the footprint of stablecoins was seen as another source of short-end Treasury demand.
While the Committee was comfortable concluding that the demand function for Treasury securities was presently healthy, several members felt that the distinction between buying Treasury securities for duration and buying Treasury securities on an asset swapped basis was meaningful. The Committee did note the reduction of demand for longer-duration sovereign debt in certain jurisdictions and, in some cases, the shift to shorter issuance from those respective debt management offices.
The Committee spent meaningful time discussing the evolution of the diversification value of Treasury securities. In recent years, the value of Treasury securities as a portfolio diversification tool has been more volatile, with Treasury securities at times being positively correlated with equity returns. Historically, this positive correlation is more evident in periods of high inflation. Reduced diversification value could be a headwind for some segments of Treasury demand, though some Committee members felt that the markets were returning to more typical countercyclical performance versus risky assets.
In terms of issuance, the Committee recommended keeping nominal coupon, FRN, and TIPS auctions sizes unchanged. The Committee continues to believe that current projections could warrant increases in coupon issuance in FY2027. The Committee had a robust discussion on the relative tradeoffs of increasing auction sizes more gradually, perhaps earlier than needed, compared to a more accelerated path of auction size increases when the financing gap is larger. The Committee also discussed the level of demand at various points on the curve, while noting that dynamics may continue to evolve prior to the need to raise coupon auction sizes. As always, the Committee felt strong communication to ensure a regular and predictable operating framework would help to facilitate any adjustment period for market participants.
Respectfully,
Deirdre K Dunn
Chair, Treasury Borrowing Advisory Committee
Jason S Granet
Vice Chair, Treasury Borrowing Advisory Committee