The debate focusing on the resilience of the U.S. Treasury market in the face of a possible interest rates increase by the Federal Reserve for the first time in nearly ten years, keeps disregarding one very important fact, which is the rapid drop in supply.
The Treasuries market has almost doubled in size since the last major financial crisis to $12.8 trillion. This is largely due to the deficit run up by the government in supporting the struggling economy and to fund the bank bail outs. However, with the economy recovering, it has started to reduce the need for additional debt.
As a result, next year’s net issuance of notes and bonds in the U.S. should decrease by around 27%, according to predictions from primary dealers who bid on auctions of Treasury debt. Coming out at $418 billion, this supply would be the lowest seen in at least eight years.
As the shrinking deficit of the nation’s budget reduces the need for extra funding, the Treasury may shift its focus from long-term to short-term debt in the form of T-bills. One of the primary dealers, JPMorgan, is predicting that the supply of T-bills will be boosted by $173 billion next year, making it the largest increase since 2008. On the other hand in the coming year, net Treasury sales of coupon bearing securities are predicted to drop to as low as $313 billion, over half of the $627 billion estimate for this year.
A drop in the supply of longer-term debt might help to keep a lid on yields, giving the Fed another reason to make the final decision and raise interest rates without incurring the risk of a sudden jump in the cost of borrowing. This may in turn, reduce the fear that an interest rate rise would cause an issue with both U.S. and global economic growth.