By Karen Brettell

(Reuters) – The U.S. Treasury Department will likely continue to reduce auction sizes next week when it releases its refunding estimates. This is after increasing issuance for coronavirus related spending.

The Federal Reserve is reducing its bond purchases, and moving closer to shrinking the balance sheet. However, this may not be the end of the Federal Reserve’s luxury.

The Fed said Wednesday that they are likely to raise interest rates for March. It also reiterated plans to stop asset purchases during this month, which were put in place in order to stabilize financial markets in the aftermath of the pandemic.

Jerome Powell (the chair of the U.S. Central Bank) promised a continued fight to contain inflation. That will involve rate hikes and likely a quicker reduction in Treasury bond holdings. The Treasury will need to replace bonds that are maturing in the Fed’s portfolio by new issuance, roughly at a rate of one for every.

Although the Fed didn’t give details as to how or when they would reduce their $9 trillion bond portfolio it was expected that the Treasury would continue to cut its quarterly bond sales. The Fed increased its auction size for debt in 2020-2021.

“We don’t have much information to really change the issuance as of now, because we just don’t have much information on what the Fed’s going to be doing,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale (OTC:). “For now, they probably continue to cut coupon issuance sizes and then re-evaluate at the May refunding.”

On Monday, the Treasury will release information about how much it anticipates borrowing next quarter. Wednesday will provide details regarding what this means for various maturities.

After the auctions ended, the biggest cuts will be seen in seven-year and twenty-year bonds. This is likely because of weak demand.

After running at $62billion between January and October 2021, seven-year note auctions have dropped to $53billion. These are now up to $32 billion from the start of 2020.

Based on estimates from primary dealers, the U.S. government appears to be overfunded. It faces a probable budget deficit of $1.35 billion in fiscal year 2022. It is lower than the $2.77 Trillion in fiscal 2021, and an unprecedented $3.13 Trillion in fiscal 2020.

Morgan Stanley (NYSE:) The ratio of debt to gross domestic product is expected to fall 7 percentage points by 2022 after it reached its highest point since World War Two, during which time the pandemic.

The Treasury is not expected to need to increase issuance of coupon-bearing debt this year, though any hastening of the Fed’s balance sheet reduction could change this outlook.

“Even under a fairly aggressive balance sheet runoff scenario, it doesn’t seem like Treasury will need to increase auctions anytime soon, and should still be set to cut them in February,” said Zachary Griffiths, a macro strategist at Wells Fargo (NYSE:).

According to the Fed, it would prefer that bond assets run out of balance sheets and not sell bonds, which might be interpreted as an aggressive tightening strategy.

As money market investors struggle to find high quality assets, they may need to increase Treasury bill issuance if needed.

“There likely would be demand for absorbing more bill issuance if that were needed,” Griffiths said.

Demand for the Fed’s reverse repo facility, which is an indicator of excess liquidity, was at $1.58 trillion on Thursday. A decrease in Treasury bills supply would reduce the Fed’s demand for reverse repo loans.