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Delicate Fed-Treasury dance keeps bonds in check By Reuters


© Reuters. This illustration of a U.S. Dollar note was taken June 22, 2017. REUTERS/Thomas White/Illustration

By Jamie McGeever

ORLANDO, Fla. (Reuters) – Delta variants, spending splurges, inflation scares and debt ceilings all threaten to bamboozle U.S. bonds, and yet it’s the delicate and often misread dance between the Fed and Treasury that’s likely keeping everything in check.

One side of this equation, the Federal Reserve may begin to cut its $80 million-a-month Treasury purchases before year end. Many investors were worried that it would weaken the market and cause yields to surge.

However, the U.S. Treasury won’t borrow as much in 2019 due to its rapidly decreasing budget deficit and increased funding needs.

If the price of both the new and existing debt supply is reduced by the same amount, then the slow withdrawal of the largest single buyer should be offset. Perhaps that is what April’s unusual stability in the bond market has been showing us.

The big question here is which one of the forces wins out – and if they are kept in check.

We don’t know the precise numbers and timeframe for the Fed to taper, nor the details of where Treasury will sell its debt. Important and unresolved variables remain inflation and wider growth.

However, the fundamental dynamics act as a strong stabilizer.

Joseph Wang, an ex-senior trader at the Fed’s open market desk reckons the two will “roughly counter each other out… So the stock of Treasury securities held by the private sector will continue growing at the same rate.” However, the Fed will only own a small percentage of overall stock.


On the funding side, Treasury will borrow significantly less in fiscal years 2022 and 2023 than this year thanks to rebounding economic growth and tax revenues, a reduced need for crisis-level support for individuals and businesses, and new spending bills being pushed further out into the future.

It will also mean that the debt-raising program will be less. A group of key participants in fixed income markets, the Treasury Borrowing Advisory Committee says that its baseline scenario requires a 19% decrease in coupon issuance for calendar year 2022, which will lead to a 35% cumulative reduction twelve months later.

Also, Treasury will be entering next year having borrowed large amounts of money in the year that followed the COVID-19 epidemic. GennadiyGoldberg, TD Securities, estimates that net coupon issuance for fiscal 2021 reached $2.73 trillion. This is an increase of $1.37 trillion over the prior year.

It wasn’t all needed. This is why Treasury’s cash balance increased at the Fed and created distortions at very short ends of the curve. Next year, borrowing will also be lower.

TBAC’s initial recommendation states that gross issuance of 2- to 30-year bonds will fall $749 billion to 3.21 trillion by 2022 and then decline further to 2.59 trillion by 2023.

This will depend on government fiscal plans. Although the Biden administration has announced ambitious spending plans totalling $3.5 trillion over the next decade, the U.S. will be tightening its fiscal policy in 2022 and 2023.

According to the bipartisan Congressional Budget Office, the deficit for fiscal 2021 of $3 trillion (or 13.4%) will drop sharply to $1.153 trillion or 4.7% GDP in fiscal 2022 and $789 billion or 3.1% in fiscal 2023.

CBO predicts that the net borrowing required for funding will fall to just below $1.5 trillion by fiscal 2022. It will then drop to approximately $750 billion in 2023. This is compared to less than $2 trillion for this year.


The Fed, meanwhile, is expected to lay out its taper timetable before the end of this year, and begin winding down its purchases of Treasuries next year. The Fed currently hoovers up $80 billion per monthly, or $960 billion each year.

It will stop buying new purchases in six to eight month’s time if it slows down at $10-$15 trillion per month.

The Fed will continue to accumulate new purchases of more than $500 Billion over the fiscal year 2022. This amount will remain around $400 billion lower than 2021 and roughly the same as government net funding requirements.

CBO estimates show that the Fed’s 960 billion in bond purchases would be offset by the $1 trillion drop in government funding over the same time period if they cut their $960 billion deficit in fiscal 2023.

There are many other factors that will influence the direction of the Treasury market in the future, including President Joe Biden’s tax-raising and stimulus plans and the outlook for inflation.

However, changes in Fed demand or Treasury supply may provide the framework for all other factors.

(By Jamie McGeever. Editing by Andrea Ricci.