Don’t Worry About Treasury Bills

The Days Ahead:

• Earnings reports, and manufacturing and services businesses surveys

This Week:

• Some incorrect points about U.S. Treasury bill issuance came up
• The Treasury Department does a great job on managing debt issues
• It’s in the midst of increasing bill issuance
• The deficit isn’t about to fall
• But financing is not a concern
• Japan against the grain…
• Raising rates and everyone likes it
• Good news on an important inflation measure

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What’s all this about T-Bill Issuance?

From time to time, a research piece hits the news and turns heads. Bad news sells. A few years ago a Wall Street analyst describes how the muni bond market was about to collapse in a round of defaults. They didn’t. Predictions for economic collapse during the GFC in 2009, were as high as -5%. They ended at +1.7% for 2009. Even the Congressional Budget Office (CBO) thought unemployment would not fall below 5% from 2015 to 2019. It hit 3.5%. Predictions are hard so follow the golden rule of forecasting: give a number and a date, but not at the same time.

Last week a “bad news” paper came out from an asset manager that caught our attention. It stated that the U.S. Treasury manipulates the bill market to manage monetary policy. The Fed controls monetary policy, so in the bond world, this was an inflammatory remark, even requiring a rebuttal from U.S. Treasury Secretary Janet Yellen.

Why the fuss? It’s a clunky report on a boring subject. First some background.

How the Treasury issues debt

A quick way to think about it is that Congress is the “how much” and Treasury the “how” part of the Treasury market.

Congress sets the budget, spending and tax rates. Spending is mostly fixed but tax revenues fluctuate depending on employment, stock gains, company profitability and sources like tariffs, fees and excise taxes. The Treasury then comes up with a number for the budget deficit. There was a budget surplus from 1998 to 2001, in 1969 and a couple of times in the 1950s. But there were only 10 surplus years from 1929 to 2024, so deficits are the norm.

The Treasury then has a number. It sets out the quarterly financing needs for the next fiscal year, from October 1^st to September 30^th. It’s presented in a very basic document but announces how much the Treasury needs to borrow. The amount is determined by new debt, which is the current year’s deficit, maturing debt that must be rolled over and any build up in cash balances of the Treasury General Account (TGA) that needs to be available in case of funding problems or emergency expenses.  

The role of the Treasury Borrowing Committee (TBAC)

When the Treasury knows how much it needs to borrow, it talks to the TBAC, an advisory group made up of dealers, banks and investors, like Vanguard, PIMCO, Bridgewater, and Rokos. They have every incentive to see successful Treasury auctions.

TBAC starts by recommending how much the Treasury could sell, and the market absorb, of bills and coupons. Bills are Treasury securities that mature in one month to two years. They are issued below par and redeemed at $100. For example, a recent 6-month bill sold for $97.51 and will redeem in January at $100. The difference between the two is equivalent to an interest rate of 5.1%

Coupons are bonds maturing between 10 to 30 years, notes between two to 10 years, and a few other instruments like Treasury Inflation Protected Securities (TIPS) and floating rate notes (FRNs). The coupon amount is fixed each quarter. The bill amount, however, is not, because the Treasury waits for up to date information on taxes and expenses.

TBAC advises on the split of the different coupons, recommending how much to sell in two-, three-, five- year and all the way to 30-year bonds. All TBAC is trying to do is gauge demand. Banks like bills. Pension funds like 30-year bonds. Mutual funds typically like 10-year notes. The Treasury can’t know all the sources of demand. TBAC helps them.

In the following table we show the current distribution of Treasury debt totaling $27,031 billion and the TBAC’s recommendation for how the next quarter’s new debt of $1,040 billion should be issued.

One item that jumps out is the recommended 65% of new bills for Q4 2024 compared to 21% for outstanding debt.

The reason for this is twofold.

First, here’s the historic amount of Treasury bills as a percent of all debt (n green) and the dollar amounts (in blue).

Treasury bill debt has ranged from a high as 43% in the mid 1970s to 9% in 2016 with a long-term average of 25%. The reason it sank so low in 2016 was that a 3-month bill yielded 0.3% and a 10-year Treasury yielded 1.4%. Few investors wanted low yielding bills and the Fed made long-term rates more attractive through its quantitative easing (QE) program. Long-term notes were thus more likely to sell and TBAC recommended that bill issuance be cut to near zero in preference of longer-dated maturities.

In 2020, Treasury issued a lot of bills because they expected emergency funding for Covid-19 was short-term. It made no sense to issue 30-year bonds for a one-year problem.

From 2022 to mid-2023, bill issuance fell from 24% to 18% because the Treasury was unable to issue any debt for six-months due to the debt ceiling impasse. That meant there were no new issues of any debt and the bills matured without being replaced.

By late 2023, TBAC recommended much higher issuance of bills because the dearth of new issuance had resulted in a shortage.

The second reason is simpler. By late 2023, bills were yielding an attractive 5.5%. Deposits into money market funds ballooned from $4,600 billion in early 2023 to $6,000 billion by early 2024. Money market funds are big buyers of bills. TBAC thought the appetite for bills was strong and recommended that:

The bill share of total marketable debt outstanding [remains]…above its recommended range given continued robust demand for bills and Treasury’s regular and predictable approach.”

This all washed out with the Treasury stating in April that they needed to finance $847 billion from April to July 2024. The TBAC said fine, here’s the split by maturity with the rest in bills. The long-term goal was to get bill debt to around 25% of the total, so bill issuance would run higher for a few quarters.

It was not much more than a portfolio rebalance to raise the amount in bills which had fallen during the 2020 to 2022 Covid-19 and 0% interest rate years.

So, what’s the problem?

A lot according to the report from Hudson Bay Capital published last week. It made three points.

One, it said that the Treasury was engaging in activist Treasury issuance (ATI) and flooding the Treasury market with too many bills and not enough coupons. This, they claimed, manipulated rates, leaving short-term rates too high and long-term rates too low.

Two, this distorted liquidity. Bills are like cash instruments, and flooding the market with bills creates too much short-term money for the economy. It was “stealth QE” designed to keep long-term rates low and equivalent to a 1% cut in the fed funds rate. This was monetary policy which is the Fed’s job, not the Treasury.

Three, the policy distorts asset prices. Specifically, that stocks are too high, bond yields too low and the economy is overheating because of excess liquidity.

And everyone agrees with them?

No! Secretary Yellen said simply that the department had not manipulated the market in any way.

Others in the Treasury pointed out that total issuance in the first nine months of the year was $143 billion less than expected and there was no need to issue as much coupon debt as expected. They also made the point that the Treasury has paid down the bill market by around $300 billion because of higher tax revenues.

We’re on the Treasury’s side.

We can’t support the assertion that the Treasury engaged in active interest rate manipulation. Here’s why.

First, the long-term chart shows bills fluctuate from 9% to 43% of total issuance. They tend to rise as the economy enters recession because rates go down. In 2002, bill issuance jumped from 21% to 27% and fed funds dropped from 6.5% to 1.5%. In 2008, bill issuance rose from 22% to 34% and fed funds fell from 5.25% to 0.25%. This is just the Treasury borrowing at the lowest rate for the shortest time to cover short-term needs like unemployment insurance. It’s straightforward asset to liability management.

Second, the current 21% is well within TBAC’s recommendations. In August 2023, it wrote:

….[TBAC] is comfortable running T-bills in the range of their longer-term historical share of 22.4% for some time before returning to the recommended 15-20% range.”

Third, there are always seasonal increases in bill issuance in February and March when the Treasury issues tax refunds. The seasonality reverses in April when non withheld taxes, for example revenues from taxes on dividends, and corporate taxes rise. This year, bill issuance rose $282 billion from January to March and then dropped $327 billion from April to May. The authors of the report omitted the data from the second quarter.

Fourth, the Treasury has always stuck to a “regular and predictable” issuance schedule. It does not want to surprise markets for the simple reason that if auctions were unpredictable, investors would demand higher rates. If the Treasury engaged in “activist issuance,” it’s probable that the market, trading over $500 billion a day, would notice.  

Fifth, even as bill issuance has risen, the weighted average maturity of U.S. Treasury debt has climbed from 65 months to 71 months since 2022. If the bill issuance was as bad and distorting as the authors say, the maturity would have fallen, not risen to near record highs.

Sixth, high bill issuance is not “stealth QE” because QE explicitly increases the Fed’s balance sheet. The Fed buys Treasury debt from banks, credits them with cash, and puts the Treasuries onto its balance sheet. Bill issuance adds nothing to the balance sheet. It just moves around the composition of the debt.

Finally, it’s hard to see how unemployment, inflation, rates or the stock market would be any different from current levels if the Treasury had issued more coupons and less bills. Sure, you can create models that may prove a point (they didn’t) but we doubt any investor thought stocks were running hot and unemployment was too low because of  temporarily higher bill issuance.

Meanwhile the deficit is still around.

We don’t agree with the conclusion of the paper and have a hard time believing the U.S. Treasury is trying to influence monetary policy. It just wants to sell bills and bonds as cheaply as it can.

But the deficit projection for 2024 is around $1,915 billion, up from $1,507 billion February and $1,300 billion a year ago. The Treasury still needs to fund the deficit and that’s a problem. But we don’t expect any “active, manipulative or distorting” policy to be part of the process.

Japan Against the Grain.        

We’ve discussed Japan a lot over the last 12 months. For over 30 years, Japan’s growth, economy, and stock and bond markets were moribund. A combination of a large asset bubble popping in 1992, deflation, demographic problems and high debt meant that for years the Bank of Japan (BOJ) kept rates at rock-bottom levels and bought 56% of all government debt. Government debt is around 230% of GDP compared to the U.S. at around 95%. The chart shows the amounts in U.S. dollars, (green) and yen (blue). The dollar line is down because of the weak yen. The BOJ has not stopped buying government bonds.

The numbers can be hard to get your head around. The BOJ’s balance sheet is $4,800 billion, 128% of GDP. At its 2022 peak, the Fed’s holdings were 34% of GDP and are now 23%.

Things began to change two years ago.

One inflation started. After decades of deflation, the BOJ was happy to see prices rise. When prices fall, consumers defer spending meaning the economy never gains traction.

Two, market reforms started to gain momentum. For example, the government’s introduced a special savings programs in January, which exempts investors from capital gains and dividend taxes. It also started a “name and shame” policy for Tokyo Stock Exchange listed companies that did not present robust plans to move their stock prices above book value.

And three, a new BOJ governor reversed the policy of negative rates.

This week saw the BOJ raise rates for only the fifth time in 30 years and announce a slowdown of bond buying. Bond buying will fall from around $38 billion a month to $19 billion by January 2026.

The immediate result was a strengthening of the yen. It’s now up 7% in a month. Stocks also rallied, especially banks, which were up 6%. Higher rates mean both higher loan margins and asset growth for banks.

Nothing happens quickly in Japan. The rate hike and reduced bond buying took years to come about. But wages are growing and inflation is up and steady. In the upside-down world of Japan, that’s good for investors.

Bottom Line

In a move that surprised no one, the Fed kept rates unchanged but laid the foundations for a September cut. The changes in language were small but unmistakable. Job gains “moderated” and inflation is in “better balance.” It was all very reassuring.

On Wednesday, we also saw the quarterly Employment Cost Index (ECI), the only in-depth report we have on wages and employer expenses. Costs for private workers were up 0.9% in the second quarter compared to 1.1% in the first. That’s all a good outlook for inflation.

Summer trading can be slow but markets liked the Fed’s language and ECI report. Small cap stocks made a 52-week high this week and the S&P 500 Equal Weight index made an all-time high. By Friday, however, the claims and employment numbers took investors by surprise and many started to take profits. Bonds, rallied with the 10-year Treasury trading as low as 3.8% compared to 4.7% in May. We’d not be too worried. Markets have come a long way and setbacks are part of the investing experience.

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Art of the Week: Natalia Goncharova (1881-1962)