Debt management in a period of quantitative tightening

Summary

  • The US Treasury market is the largest and deepest of all issuers in the world, while US Treasury securities are a key benchmark in global financial markets.
  • The market faces some uncertainty as the Treasury’s biggest client of late, the Federal Reserve, stops buying and eventually reduces its holdings of Treasuries.
  • As Treasury debt managers grapple with this challenge, the quarterly repayment process will serve as a crucial forum to ensure regular and predictable debt issuances.

introduction

Federal finance is in a somewhat delicate dance, with the Treasury Department having to adjust its debt management operations while its biggest client, the US Federal Reserve, embarks on a tightening of monetary policy. The central bank has signaled its intention to reduce its holdings of Treasuries as it moves away from the extraordinarily accommodative monetary policy of the recent past and, to a large extent, the past decade. This has important implications for financial management as well as fiscal policy. To help the Treasury assess the market’s appetite for federal debt, the Office of Treasury Debt Management convenes the Treasury Borrowing Advisory Committee, or TBAC, on a quarterly basis as part of what the this is called the quarterly repayment process. This process provides a forum for the regular exchange of views and information between Treasury officials and key players in the market for buying and selling Treasury debt. Given the unique stresses facing Treasury debt management, this week’s quarterly repayment announcement provides an opportune time to assess the institutional outlook for federal finances.

The Quarterly Reimbursement Process

The US Treasury market is the largest and deepest market of any issuer in the world. US Treasury securities are considered essentially risk-free and serve as a fundamental benchmark in global financial markets. The engine room of the world’s deepest government securities market is the Treasury’s Office of Debt Management, headed by a career federal official. Ultimately reporting to the Assistant Secretary for Federal Finance and housed within the Office of Internal Finance of the Treasury, the Office of Debt Management is responsible for formulating policy for the borrowing needs of the federal government.

The core mission of the office is to fund federal government bonds at the lowest cost over time. This mission is challenged by necessary uncertainties in federal cash flows, federal borrowing requirements, treasury markets and the broader macro economy. Whether the Treasury seeks to manage costs over time is also a key consideration and necessarily depends on the outlook for federal finances. For example, short-term interest rates are generally lower than long-term rates, perhaps suggesting that a cost-conscious treasury would generally prefer to fund federal bonds with short-term debt, such as government bills. Treasury, which have maturities of less than one year. . But funding the federal government through short-term bills comes with risks over time. A 52-week Treasury bill may have a lower interest rate than a 30-year bond, but depending on future interest rates, it may be cheaper for the federal government to fund a bond with a bond. at 30 years than 30 successive bonds at 1 year. securities, particularly given the great uncertainty of interest rates over a 30-year period. As an analogy, consider a homebuyer choosing between a 30-year fixed mortgage or a shorter-term adjustable rate mortgage (ARM). The buyer may be better off today with an ARM, but may be sorry when interest rates rise.

Managing this balance is an essential task of the Debt Management Office. For decades, the Treasury has adhered to the principle that debt issuance should be “regular and predictable”. In practice, this principle drives the regular timing of Treasury auctions, the deliberate process of changing debt management policy, and clear communication to market participants. The quarterly reimbursement process is essential to these activities.

Quarterly repayment

Four times a year, Treasury debt managers engage in a formal process to refine federal debt management policy known as the Quarterly Treasury Repayment Process. As part of this process, Treasury solicits the views of its most important direct clients – the primary traders. Primary dealers are major financial institutions that purchase Treasury securities directly from the Federal Reserve Bank of New York, which acts as the fiscal agent for the US Treasury Department and, in effect, the federal government. There are currently 24 primary dealers who can and should participate in direct purchases of Treasury securities at auction. More formally, the Treasury convenes the Treasury Borrowing Advisory Committee (TBAC) to advise it on market conditions and respond to the Treasury’s views and intentions regarding debt management. The TBAC is a federally chartered advisory committee to the Department of the Treasury. While the charter allows for up to 20 members, the current membership is made up of 15 senior representatives of primary traders, institutional investors and other major players in the Treasury markets.

As part of this process, the TBAC meets with key Treasury officials once a quarter to exchange views on Treasury markets and expected developments in federal borrowing. While the meeting itself is private to protect the sensitivity of the discussion, sanitized minutes of the meeting are released the following day. In addition to serving as an advisory function, the quarterly repayment process is also the forum in which the Treasury makes public major changes in its debt management policies and outlook, again in accordance with the principle of regularity and predictability in management. Treasury debt.

Based on a review of the TBAC’s most recent official statement to the Treasury and the Treasury Policy Statement, it is clear that federal finances face key uncertainties as the Treasury’s largest customer, the Reserve federal government, is preparing to reduce its Treasury holdings in the coming month.

The Federal Reserve: the Treasury’s best client

Since the global financial crisis, monetary and fiscal policies have increasingly overlapped. Through a number of operations, generally referred to as “quantitative easing”, the Federal Reserve has dramatically increased direct purchases of federal securities to support low interest rates and, in turn, support the US economy in the face of to the Great Recession and, more recently, the COVID -19 pandemic. Fiscal policy has also broadened, alongside higher borrowing requirements. Indeed, between the end of February 2020 and the end of December 2021, US marketable debt held by the public increased by more than $5.6 trillion. For budget watchers, this is an alarming increase in debt. Yet it also demonstrates the extraordinary borrowing power of the United States and the appetite for US Treasury securities in global markets.

It is important to note, however, that the Treasury has benefited from the assistance of the statutorily independent Federal Reserve. While US debt increased by more than $5.6 trillion, the Federal Reserve’s Treasury holdings increased by $3.2 trillion. As part of the coupon auction offerings (Treasury auctions for bills and bonds), the Federal Reserve bought up to 40% of the securities on offer – a share more than twice as much as it ever bought during the extraordinary actions of the Federal Reserve during the Great Recession.

This dynamic also has consequences for fiscal policy. The Federal Reserve remits its net income to the Treasury, which necessarily includes the interest it earns on its large Treasury portfolio. In fiscal year 2021, the Federal Reserve returns more than $100 billion to the Treasury, a significant portion of which is mostly recycled interest payments. For Treasury markets, the loss of this big buyer is a challenge for market participants, such as those represented by TBAC and Treasury debt managers, to navigate.

However, as the labor market quickly recovered from the brief 2020 recession, inflationary pressures outpaced nominal wage growth, precipitating a rapid change in monetary policy. The Federal Reserve is widely expected to raise interest rates at its March meeting and begin phasing out its Treasury holdings later this year. In its Treasury submission this week, the TBAC estimated that the Federal Reserve’s Treasury runoff would create a need for the Treasury to find new buyers for $1.6 trillion in new debt securities over the next three months. coming years.

A key example of the “win-win” of the quarterly repayment process is reflected in the TBAC’s report to the Secretary of the Treasury, which substantially responds to Treasury policy statements and borrowing estimates, among other communications. It should be noted that in this week’s report, the TBAC advised the Treasury to adjust its planned cuts to certain debt issuances in light of the potential reduction in demand from the Federal Reserve and in light of market conditions. observed.

Conclusion

The US central bank is embarking on an epochal shift in its monetary policy, which has been largely accommodative for more than a decade. This change is occurring in a relatively rapid manner which has shaken the markets and also poses challenges to public finances. The Federal Reserve became the Treasury Department’s best customer, just when “business” was booming. As the Federal Reserve unwinds its portfolio, the quarterly redemption process will play a key role in ensuring that US Treasury markets remain attractive to investors, while funding Federal bonds as efficiently as possible.

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