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The Federal Reserve may have to adjust its bond buying program to accommodate the huge issuance of long-term debt lined up by the Treasury Department, according to strategists.
Government bond prices fell on Wednesday, pushing yields near record lows across a range of maturities after the Treasury announced plans to sell a record $ 112 billion of outstanding debt next week. in three, 10 and 30 years.
It also announced significant increases in the auction size of its long-term debt over the next three months to fund the unprecedented aid plans passed by U.S. lawmakers since March and the new stimulus bill now. under development by Congress.
Strategists are now warning of potential bond market indigestion if the US central bank ultimately does not shift its bond purchases to long-term debt.
“The Treasury is putting increasing pressure on the Fed to extend the duration of its purchases,” said Priya Misra, global head of rate strategy at TD Securities. “It’s almost a necessity now. Without it, we could have a messy treasury market both in terms of operations and auctions. “
The auction size for 10-year bonds will increase by $ 6 billion from the previous quarter to $ 38 billion, the Treasury said on Wednesday, while those for 20 and 30-year bonds will increase by 5 and 4 respectively. billions of dollars.
Given the expected rise in auction sizes for two-, three- and five-year notes and other instruments, the Treasury said this equates to $ 132 billion in additional issues over the next three months. compared to the previous period.
So far, bond investors have largely ignored the global upturn in government debt issuance, betting that it will be offset by equally broad central bank bond buying programs.
But the scale of the latest increase in emissions surprised market participants.
Immediately after the announcement, 10-year Treasury prices fell, pushing yields higher from record levels reached on Tuesday. Yields on 20- and 30-year bonds also increased, as did those on seven-year bonds.
At the height of the financial panic in March, the Fed pledged to buy an unlimited amount of government debt, seeking to contain tensions that arose in the world’s largest bond market.
After buying up to $ 75 billion in Treasuries a day, the Fed has since slowed the pace of its bond purchases. He now buys around $ 80 billion per month on all maturities. Analysts say the need to move buying is not urgent, but it could become more pressing as the year progresses.
The purchases, coupled with increased investor demand in the face of a worsening economic outlook, have helped push Treasury yields to all-time lows, but the next wave of longer-term debt issuance could change this dynamic, according to strategists.
In addition, they warn that the borrowing estimates put forward by the Treasury – an additional $ 2.2 billion by the end of the year – could rise further if another fiscal stimulus package beyond the one currently being debated. was implemented.
Previously, the Treasury relied on the Treasury bill market, with maturity dates of one year or less, to meet its borrowing needs, and the markets easily digested the new supply. But, according to Subadra Rajappa, head of US interest rate strategy at Société Générale, demand for long-term debt can be more ad hoc.
“The risk is that you won’t see demand materialize continuously,” Rajappa said, adding that this would help the Fed shift the average maturity of its Treasury holdings.
Jon Hill, rate strategist at BMO Capital Markets, called the increases in Treasury auctions “aggressive,” adding that the sluggish economy was an even more pressing reason for the Fed to adjust its budget. purchase of bonds.
“[Inflation expectations] are weak and the economy is still struggling, ”he said. “In March and April, the Fed was focusing on how the market works. Now things have calmed down considerably, but we still need quantitative easing to squeeze long rates and lower borrowing costs. “