Diy13
By modifying the maturity profile of its debt issuance, the U.S. Treasury Department is adeptly steering financial conditions and, by extension, the broader economy, thereby encroaching upon the fundamental roles traditionally held by the Federal Reserve, according to a recent study published by Hudson Bay Capital.
This novel tool showcasing the tug of war between fiscal and monetary policy, which authors Stephen Miran and Nouriel Roubini dubbed “activist Treasury issuance” (“ATI”), “has been a major market driver over the past year, and we expect it will continue to play a significant role in the year ahead; ATI may become a regular element of the policy toolbox, driving political business cycles in the market and the economy.”
Indeed, the Treasury, led by Janet Yellen, has been funding the federal budget deficit with outsized issuances of short-dated debt (i.e., Treasury bills). The problem with the government’s reliance on T-bills, rather than longer-dated coupons, is it’s meddling with the Fed’s ability to contain inflation, the paper argued.
“Contrary to the Fed’s insistence that monetary conditions are quite restrictive, they are not, and Treasury’s issuance policies help explain the persistence of inflation and strong economic growth.”
Even with the most stringent policy tightening measures in decades, financial conditions remain loose, and the economy broadly continues to perform well. This is largely due to the Treasury’s “hidden quantitative easing” strategy, which involves limiting the supply of long-term debt. While the Fed’s QE addresses the demand side, ATI initially constrains the supply of duration.
The budget deficit significantly widened during the presidency of Donald Trump, who implemented substantial tax cuts. Since then, the shortfall has ballooned further due to extensive federal outlays on pandemic-related relief, as well as economic recovery efforts and aid to Israel and Ukraine. Also, rising interest expenses, exacerbated by two-decade high borrowing costs, have further contributed to the growing deficit.
Last month, the Congressional Budget Office upwardly revised its 2024 estimate for the budget deficit to $1.9T from $1.5T, owing to increased expenses on student loans, foreign aid, and higher projected spending for Medicaid.
Meanwhile, there has been no shortage of demand for the increased T-bill supply, with yields on these safe and liquid bonds quite elevated. Still, the higher share of bills as a percentage of marketable debt outstanding (currently standing at ~22%) has raised some concerns. Economists Miran and Roubini contended that anything exceeding 18% qualifies as ATI.
As such, the “missing” long-term debt has led to the 10-year Treasury yield (US10Y) falling by 0.25 percentage points over the past year, they said. And the Treasury’s issuance policies are equal to 1% in Fed rate cuts, they added. The authors estimated that the bill supply as a percentage of outstanding debt has fluctuated between 34% and 60% in recent quarters, contending that this undermines the central bank’s efforts to combat inflation.
If ATI is unwound through terming out $1T of excess T-bills, the 10-year yield (US10Y) may rise by 50 basis points, which the authors said would have similar economic effects as a two-quarter-point rate hike by the Fed. On the other hand, if ATI is not unwound and becomes a permanent tool, “we are likely to see higher equilibrium inflation and interest rates priced in over time due to political business cycles becoming reality,” the paper said.
Do note that the Treasury will be publishing next week its quarterly refunding announcement, which includes the Treasury’s borrowing plans for the coming three months.
Dear Readers: We recognize that politics often intersects with the financial news of the day, so we invite you to click here to join the separate political discussion.