Original author: Dong Jing

Original source: Wall Street Journal

U.S. Treasury Secretary Scott Bessent has adopted a more proactive strategy in national debt management, a shift that is disrupting the long-standing predictability of the U.S. bond market, prompting Wall Street to urgently simulate potential significant adjustments in government borrowing strategies in the coming months.

According to a report by Bloomberg on August 26, with the announcement last week of a bond repurchase plan referred to by Bessent as the “Treasury twist,” the market's focus has quickly shifted to the Treasury's quarterly bond issuance plan on November 4. Strategists at Wall Street investment banks such as Bank of America and Deutsche Bank have warned that this upcoming announcement has become an unprecedented unknown for the $31 trillion U.S. Treasury market.

Currently, mainstream institutions on Wall Street expect that the Treasury might signal in November that future borrowing increases will be completed through short-term Treasury bills and shorter-duration notes, while also further expanding the repurchase scale to alleviate pressure on long-term yields. Some investment banks have even pointed out that the possibility of directly cutting long-term bond issuance has been increasing.

As long-term Treasury yields hover at multi-year highs, the Treasury's deviation from the long-standing practice of being “regular and predictable” is injecting new volatility into the market. Investors are facing a whole new era of U.S. debt management and are reassessing their portfolio's risk exposure accordingly.

November Bond Issuance Plan Becomes Market “Unknown”

Bessent's recent moves have broken the long-standing calm in the U.S. policymaking arena. Bank of America Corp's Managing Director of U.S. Interest Rate Strategy Meghan Swiber stated that the bond market is entering “a whole new world” of U.S. debt management.

Although Bessent currently rules out changes to the regular auction plan and states that the Treasury will adhere to the current schedule at least until the announcement of the next bond issuance plan, market expectations have already changed.

BMO Capital Markets’ head of U.S. interest rate strategy Ian Lyngen pointed out that Bessent's actions have effectively turned the November bond issuance announcement into a massive unknown. He emphasized that it can no longer be ruled out that the scale of bond auctions will be reduced.

Moreover, the Treasury made subtle wording adjustments in its recent bond issuance guidance, indicating that officials are evaluating potential “changes” in future sales of coupon and floating rate notes, rather than the “increase” mentioned in prior guidance. Analysts believe that this provides the Treasury with more leeway to reduce long-term bond issuance.

Strategic Game of Expanding Repurchase and Shortening Duration

Reportedly, as the first step of adjustments, the Treasury may tweak its repurchase operations. The strategy team led by Steven Zeng at Deutsche Bank AG believes that the Treasury may raise the scale of long-end operations above the initially suggested $4 billion minimum.

Officials may even keep the operating scale confidential until the day before the operation, reducing the predictability of the repurchase plan and significantly raising the threshold for investors to short long-end Treasuries.

However, the expanded repurchase operations alone are unlikely to achieve a substantive shift in the government's debt maturity. Unlike the Federal Reserve, the Treasury cannot create funds out of thin air to finance its purchasing activities. This means that the repurchase must ultimately be funded through additional issuance (most likely short-term Treasury bills) or by using cash from the Treasury's accounts.

Morgan Stanley notes that the Treasury account can provide $80 billion to $200 billion for the repurchase.

Morgan Stanley's interest rate strategist Martin Tobias stated that the expanded repurchase may only serve as a transition until the November bond issuance plan is finalized. He believes that the event ultimately triggering market volatility will be the method the Treasury uses to shorten the weighted average duration.

Tobias expects the Treasury to gradually increase the sales of shorter-term notes while keeping long-term bond sales stable, but the risk of directly cutting long-end bond auctions has risen over the past week.

Tail Risk and Controversy of Reducing Long Bond Issuance

Some strategists are considering more radical reform proposals.

Citi has pushed its forecast for larger-scale auctions to 2028 and increased the tail risk that the Treasury may ultimately cancel the 20-year Treasury bond, which was reintroduced by the Trump administration's first Treasury Secretary Steven Mnuchin in 2020.

Despite being shorter in duration, the current yields on 20-year Treasuries are similar to those on 30-year Treasuries, which seems illogical given the upward sloping yield curve in the U.S.

Citi's head of U.S. interest rate strategy Jason Williams stated that given the poor trading performance of the 20-year Treasury bond relative to the 10-year and 30-year Treasuries, the Treasury will likely reduce its auction size, with the 20-year Treasury likely to benefit the most from future actions.

However, reports indicate that directly cutting long bond issuance faces practical challenges. The Treasury stopped selling 30-year bonds in 2001, but the fiscal context at that time was completely different, with budget surpluses reducing the government's financing needs. In the current period of high issuance, any move to cancel a bond of a certain maturity would force other maturity bonds to absorb that borrowing.

WisdomTree's head of investment strategy Kevin Flanagan warned that reducing issuance on the long end of the curve while compensating elsewhere seems mathematically very difficult. He stated that if the Treasury goes down this path, the market will see it as manipulation, which could ultimately backfire.

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