Wall Street Asks: What's Bessent's Next Move to Rescue US Debt?

Original author: Dong Jing

Original source: Wallstreetcn

US Treasury Secretary Scott Bessent has adopted a more proactive strategy in national debt management, a shift that is upending the long-standing predictability of the US bond market and prompting Wall Street to urgently game out potential major adjustments to the government's borrowing strategy in the coming months.

According to a Bloomberg report on Aug. 26, following last week's announcement of a bond buyback program that Bessent called a "Treasury twist," market focus has rapidly shifted to the Treasury's quarterly refunding announcement on Nov. 4. Strategists at Wall Street banks including Bank of America and Deutsche Bank warn that for the $31 trillion US Treasury market, this upcoming announcement has become an unprecedented unknown.

Currently, mainstream Wall Street institutions expect that the Treasury may signal in November that future increases in borrowing will be met through Treasury bills and shorter-dated notes, while further expanding buybacks to ease pressure on long-term yields. Some banks even point out that the likelihood of the more aggressive option of directly cutting long-term bond issuance is rising.

With long-term Treasury yields hovering near multi-year highs, the Treasury's deviation from the long-standing practice of "regular and predictable" issuance is injecting new volatility into the market. Investors are facing a new era in US debt management and are reassessing their portfolio exposures accordingly.

November Refunding Becomes a Market "Unknown"

Bessent's recent moves have broken a long period of calm in US policy circles. Meghan Swiber, managing director of US rates strategy at Bank of America Corp, said the bond market is entering "a whole new world" of US debt management.

Although Bessent has for now ruled out changes to the regular auction schedule and said the Treasury will stick to the current timetable at least until the next refunding announcement, market expectations have already shifted.

Ian Lyngen, head of US rates strategy at BMO Capital Markets, pointed out that Bessent's actions have effectively turned the November refunding announcement into a huge unknown. He stressed that the possibility of reducing auction sizes can no longer be ruled out.

In addition, the Treasury made a subtle wording change in its latest refunding guidance, saying officials are evaluating potential "changes" to future coupon and floating-rate note sales, rather than the "increases" mentioned in previous guidance. Analysts believe this gives the Treasury more room to reduce issuance of longer-dated debt.

Strategic Game of Expanding Buybacks and Shortening Duration

According to the report, as a first step, the Treasury may tinker with its buyback operations. A team of strategists at Deutsche Bank AG led by Steven Zeng believes the Treasury could increase the size of long-end operations above the initially suggested minimum of $4 billion.

Officials could even keep the size of operations secret until the day before, thereby reducing the predictability of the buyback program and significantly raising the bar for investors to short long-end Treasuries.

However, expanded buybacks alone are unlikely to achieve a material shift in the maturity profile of government debt. Unlike the Federal Reserve, the Treasury cannot create money out of thin air to finance its purchases. This means buybacks must ultimately be funded through additional issuance (most likely Treasury bills) or by using cash from the Treasury General Account.

Morgan Stanley notes that the Treasury General Account could provide $80 billion to $200 billion to fund buybacks.

Morgan Stanley rates strategist Martin Tobias said expanded buybacks themselves may be just a bridge until the November refunding announcement. He believes the event that will ultimately trigger market volatility will be how the Treasury shortens the weighted average maturity.

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

Tail Risks and Controversy of Cutting Long-End Issuance

Some strategists are considering more aggressive reform options.

Citigroup has pushed back its forecast for larger auctions to 2028 and raised the tail risk that the Treasury could eventually eliminate the 20-year bond. That maturity was reintroduced in 2020 by Steven Mnuchin, the first Treasury secretary of the Trump administration.

Despite its shorter maturity, the 20-year bond currently yields about the same as the 30-year bond, which seems counterintuitive against the backdrop of an upward-sloping US yield curve.

Jason Williams, head of US rates strategy at Citi, said, Given the poor trading performance of the 20-year bond relative to the 10-year and 30-year, the Treasury is likely to reduce its auction size, and the 20-year bond could benefit the most from future actions.

However, the report notes that directly cutting long-end issuance faces practical challenges. The Treasury stopped selling 30-year bonds in 2001, but the fiscal backdrop was very different then, with budget surpluses reducing the government's financing needs. In the current period of high issuance, any move to eliminate a maturity would force other maturities to absorb that borrowing.

Kevin Flanagan, head of investment strategy at WisdomTree, warned that cutting issuance at the long end of the curve and making up for it elsewhere seems mathematically very difficult. He said, If the Treasury goes down this path, the market will view it as manipulation, which could ultimately backfire.