A tactical guide to the upcoming quarterly refunding announcement for bond and stock markets

QRA expectations: coupon gross issuance to keep above $1 trillion as the RRP falls to zero.

As per the Treasury's financing estimates released on January 29th, the Treasury anticipates $202 billion in net debt issuance, based on an assumed cash balance of $750 billion by the end of June.

Although this quarterly estimate is significantly lower than any quarterly net debt issuance since the third quarter of 2022, the recommended US Treasury financing schedule from Treasury Borrowing Advisory Committee (TBAC) suggests that coupon issuance will not decrease from the first quarter of 2024. In fact, coupon issuance is poised to increase by roughly $89 billion across tenors from slightly over a trillion quarterly to $1.1 trillion. Certain tenors (2-, 3-, 5-, and 10-year) will maintain the record-size sale amounts witnessed in the last quarter.

The decision to increase coupon issuance may be attributed to the steady decrease in the RRP facility, which has dropped from a peak of over $2 trillion in the last quarter of 2022 to slightly above $400 billion today. As outlined in a previous analysis, as the RRP facility depletes, policymakers grow concerned about potential liquidity shortages in money markets. Consequently, they are compelled to enact measures aimed at constraining the supply of T-bills and reducing their runoff from the Fed's balance sheet. These actions are intended to mitigate the depletion of the RRP facility and reserves within the Federal Reserve system.

It is therefore very unlikely that today we are entering a scenario similar to the last quarter of 2023, where the US Treasury managed to alleviate selling pressure from the long end of the yield curve by increasing T-Bill issuance while significantly reducing notes and bond issuance. During that period, the RRP facility was close to $1 trillion, more than twice the level it is today. The heightened issuance of T-Bills then resulted in a faster depletion of the RRP Facility. Therefore, the choice to increase coupon issuance sale instead of T-Bills seems prudent.

While coupon issuance remains elevated, there's encouraging news on the horizon. Factoring in upcoming bills and coupon redemptions, and the latest Treasury financing estimates, the total gross issuance of U.S. Marketable Treasury securities is projected to decline for the first time since the second quarter of 2022. 

Therefore, the big focus for markets shifts towards announcement concerning the Treasury General Account (TGA) level. The TGA is essentially the main checking account for the U.S. government. It's held at the Federal Reserve and serves as the government's primary operating account, used for managing its daily cash flows, including collecting taxes, making payments, and managing debt issuance and redemption.

If the forthcoming QRA aligns with anticipated issuance, but the TGA target increases that means that the government intends to hold more cash reserves. This could bear negative implications for markets, because more cash being held in the TGA means less money being injected into the economy, potentially slowing down economic growth. Conversely, if the TGA is maintained at its current level of $750 billion or lower, it implies no change or the potential release of more funds into the economy, providing a boost to economic activity. This might lead to a bullish sentiment in risky assets such as stocks and lower rated corporate bonds.

Why is the quarterly refunding announcement important?

The quarterly refunding announcement (QRA) by the US Treasury is important because it outlines the government's borrowing plans for the upcoming months. It provides crucial information about the issuance of Treasury securities, such as Treasury bills, notes, and bonds, which are essential for funding government operations and managing the national debt. Investors closely monitor these announcements to gauge the supply of Treasuries in the market, which can impact bond prices, yields, and overall market sentiment.

Over the past year, the Quarterly Refunding Announcement (QRA) has gained increasing market significance, driven by the necessity to issue more debt to finance a sizable deficit.

What truly influences markets, especially bond yields, is the announcement detailing the projected distribution of issuance across different tenors. When the US Treasury opts to increase T-bill issuance while keeping coupon issuance unchanged, long-term US Treasuries experience relief from selling pressure, as the overall supply isn't expanded. However, if coupon supply increases, markets must brace themselves to absorb the added supply, even without support from the Federal Reserve due to Quantitative Tightening.

The impact of the QRA is illustrated in the chart below. Following last November's QRA, which revealed an uptick in T-bill issuance rather than coupon issuance, the term premium on a 10-year zero coupon bond dipped below zero. Conversely, after the January QRA indicated an increase in coupon bond issuance, the same premium surged well above zero.

The aforementioned developments had significant repercussions for the stock market. When the term premium began to decline in the last quarter of 2023, we witnessed a rally in the stock market, propelling the S&P index to new highs. Conversely, with rates now rebounding, we observe a decline in the stock market.

What is term-premium and why is it important in bond markets?

The term premium is the extra return investors demand for holding longer-term bonds compared to shorter-term ones. It's crucial because among other things, it signals changes in investors’ expectations and it might lead to monetary policy decisions.

A higher term premium indicates that investors purchasing US Treasuries are seeking a greater premium to hold onto these securities. This could reflect expectations of persistent inflation, anticipated interest rate hikes, or heightened perceptions of credit risk. The Federal Reserve closely watches rising term premium as it can affect borrowing costs for businesses and households, influencing economic activity and inflation trends. If the term premium is elevated, it suggests tight financial conditions, possibly reducing the need for further interest rate hikes. Conversely, if the term premium is negative and inflation rebounds, it may prompt the Federal Reserve to raise rates.

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