The U.S. Treasury is expected to refuse to change its guidance on Treasury bond issuance. The short-term debt "dependency" may face the risk of interest rate shocks.

The debt management team led by U.S. Treasury Secretary Janet Yellen has long resisted Wall Street's suggestions to adjust future U.S. Treasury issuance guidance, resulting in many primary dealers no longer expecting relevant policy changes in the short term. Before Wednesday's quarterly debt strategy statement is released, most primary dealers anticipate that the Treasury will reaffirm its previous stance of not increasing the issuance of medium- and long-term securities (notes and bonds) at least for the next several quarters. This forward guidance dates back to the Biden administration. Yellen has previously criticized this approach, believing it aims to keep long-term borrowing costs low ahead of the November 2024 elections. Currently, the U.S. presidential elections are facing the Republican administration led by Donald Trump, and any signals indicating an increase in Treasury auction sizes could lead to further rises in U.S. Treasury yields, which would not be in the government's interest. Last week, the yield on the 30-year U.S. Treasury bond rose to its highest level since 2007. With the financing costs of long-term bonds already significantly higher compared to short-term debt, many traders are skeptical about whether the Treasury will actually expand its long-term issuance in the coming years. Since taking office, Yellen has relied on short-term Treasury bills (with maturities of up to one year) to meet the governments growing financing needs. Due to lower interest rates on short-term Treasury bills, this strategy has helped control the Treasury's financing costs. However, this strategy also poses risksrelying on short-term bills means that debt service costs will be more susceptible to shocks from short-term interest rates, and currently, investors are betting that the Federal Reserve may be forced to tighten monetary policy in the coming months. The U.S. Treasury is highly reliant on short-term Treasury bills to meet its financing needs. RBC Capital Markets' head of U.S. interest rate strategy, Blake Gwinn, stated, The U.S. Treasury should adjust its guidance to preserve more options. This approach may carry the risk of pushing up yields, but this shift will happen sooner or later. The longer it is delayed, the greater the importance and impact of the market on the eventual removal of this guidance. The U.S. Treasury will update its current quarterly financing demand estimates on Monday, followed by the release of the so-called quarterly refinancing announcement on Wednesday. In May of this year, the Treasury projected a net financing need of $671 billion for the three months ending in September. According to calculations from Bank of America, if the Treasury maintains its current issuance scale of coupon-bearing bonds (i.e., notes and long-term bonds) until the end of FY2027, the proportion of short-term Treasury bills to total outstanding government debt will rise to nearly 25%, the highest level since 2004 (excluding anomalies during the COVID-19 pandemic and the global financial crisis). The Treasurys Borrowing Advisory Committee had previously suggested that the proportion of short-term Treasury bills should average around 20%. The Treasury currently has reason to believe that strong demand can at least temporarily absorb the new supply. According to Crane Data LLC, the size of money market funds has now grown to about $8.3 trillion. Yellen also indicated that stablecoin issuers could potentially become a new source of demand for short-term Treasury bills in the future. Meanwhile, the Federal Reserve is increasing its holdings of U.S. Treasuries, partly due to reinvesting proceeds from maturing mortgage-backed securities into short-term Treasury bills. Since the last quarterly refinancing announcement in May, dealers have continuously postponed their expectations for when the Treasury will start increasing coupon-bearing bond issuance. Many now estimate that this change may not occur until as early as May 2027. Regarding the refinancing Treasury auctions next week, if the issuance volume remains unchanged, it will include: $58 billion in 3-year U.S. Treasuries to be issued on August 11; $42 billion in 10-year U.S. Treasuries to be issued on August 12; and $25 billion in 30-year U.S. Treasuries to be issued on August 13. Economists anticipate that the U.S. federal budget deficit will remain around $2 trillion in the coming years, which means the government will need to continue increasing its borrowing. As time goes on, the significant amount of maturing debt means that the current auction size will not be able to raise new funds for the Treasury. J.P. Morgan analysts believe that starting from FY2027 (beginning October 1), the U.S. Treasury will face a financing gap. The bank estimates that the cumulative financing gap from 2027 to 2030 may reach $3.7 trillion. In a refinancing preview report released last week, the J.P. Morgan strategy team led by Jay Barry wrote, From a prudent debt management perspective, we believe the Treasury should eliminate the word at least from its long-standing forward guidance next week. However, they added, Political factors are at play. They pointed out that the Trump administration has an incentive to avoid rising Treasury yields before the election. Additionally, Yellen has also been focused on lowering long-term yields. A few institutions expect the U.S. Treasury to adjust its guidance. Although most primary dealers expect the U.S. Treasury to reaffirm its stance of not increasing medium- and long-term bond issuance at least for the next several quarters, some banks, including Deutsche Bank, Wells Fargo, and CIBC Capital Markets, believe that the U.S. Treasury may adjust its issuance guidance on Wednesday to prepare for an earlier increase in coupon-bearing bond issuance. While the specific wording may take various forms, the key is to provide sufficient flexibility for the Treasury to announce policy adjustments as early as next February. Nonetheless, market confidence in this change remains low. The Wells Fargo team led by Michael Pugliese stated, If the Treasury again avoids adjusting its language, we would not be surprised at all, especially since the November refinancing announcement will be released the day after the election. However, the team also believes, Based on fundamentals and previous recommendations from the Treasury Borrowing Advisory Committee, this change should eventually come. The Treasury Borrowing Advisory Committee consists of investors, primary dealers, and other market participants. When the Treasury finally increases its coupon-bearing bond issuance, most dealers expect the new issuance to be concentrated mainly in short- and medium-term securities, rather than in long-term bonds of 10, 20, or 30 years. The yield curve's mid-section is currently under less pressure. Over the past weekend, the yield on the 5-year U.S. Treasury bond was about 4.45%, lower than the 4.73% for 10-year Treasuries and 5.27% for 30-year Treasuries. In May, the Treasury indicated that officials were exploring the possibility of increasing coupon-bearing bond issuance, focusing on structural demand trends and the potential costs and risks associated with differing issuance structures. TD Securities strategists Genadiy Goldberg and Molly Brooks wrote in a report, This statement suggests that any future action by the Treasury to increase coupon-bearing bond issuance may tend to favor the front end of the yield curve. Traders will also be watching to see if the Treasury provides further indications of its interest in investing excess cash in the repurchase market. Treasury officials have previously inquired about primary dealers' views on this initiative in routine pre-refinancing surveys.