Global Rates Notes: May 2022 Refunding Preview

• We expect Treasury to announce a final round of nominal auctions size cuts, concentrated at longer maturity sectors, at its May refunding meeting. Our assumption for cuts imply a drop in gross nominal supply from $780bn per quarter to $759bn. We think further supply reductions beyond this refunding quarter are unlikely given our expectations for the Fed to begin balance sheet runoff in May.
• While we are penciling in proportionately higher cuts at the 20y point, we think ongoing liquidity considerations raise some risk of an even larger reduction. On TIPS, we expect Treasury to proceed with gradual TIPS increases through the course of the year. Any further increases to supply will likely be a function of how market conditions evolve as the supply backdrop shifts and underlying inflation moderates.

May 2022 Refunding Preview

After two successive rounds of nominal issuance cuts, we expect a third, final round of smaller and more targeted reductions at next week’s May refunding meeting. The February meeting indicated a range of views on the outlook for future cuts, given uncertainty around financing needs, but the Treasury Borrowing Advisory Committee ultimately recommended a pared back round of cuts in May, concentrated in 7y to 30y maturities. Our own fiscal outlook hasn’t really shifted since the last meeting— our economists continue to expect deficits in the $1-1.2tn range in FY22-24. At the upcoming quarterly refunding meeting, we still expect Treasury to enact $1bn/month cuts to 7s, and quarterly cuts of $1bn to 10s and 30s each and $2bn for 20s, roughly in line with the TBAC recommendation (summarized in Exhibit 1). This would translate to a $21bn decline in gross nominal supply per quarter (to $759bn).

There are two areas where we expect particular attention. First, given the relative cheapness and liquidity challenges around the 20y point, we are penciling in somewhat larger cuts at the 20y point in comparison to 10s and 30s. We think risks are tilted toward even larger cuts, though better reception for 20y auctions in recent months may temper these risks. Second, TIPS remain an area where Treasury continues to leave the door open to future increases in issuance sizes. We see a strong case for Treasury to continue with gradual $1bn increases to 5y and 10y TIPS supply at least this year, given still robust appetite for inflation protection and a historically low TIPS share. We think further increases are plausible, but expect Treasury to take a measured approach given an uncertain inflation environment growing reliance on non-Fed buyers following a period of flat to negative net TIPS supply.

With the start of quantitative tightening imminent, could the Treasury hold off on making some of the cuts we discussed? While possible, we see low likelihood of this for two reasons. First, we think a more bills-focused approach to meeting the increased financing need from Fed runoff is a more prudent approach given the market’s significant capacity to absorb such supply. We project net bill issuance of $250-300bn in 2H22 and $475bn in CY2023, assuming the Treasury keeps its $650bn target for its cash buffer (Exhibit 2). Taken together with our nominal and TIPS projections, this issuance mix should leave the bill share of Treasuries outstanding comfortably within the 15-20% recommended range. Second, Treasury appears somewhat disinclined to cut issuance solely at points that appear to have been oversupplied and prefers to package together those adjustments with broader adjustments. To the extent Treasury maintains these views, continuing with a small round of cuts this time appears to be the most likely outcome.