Report to the Secretary of the Treasury from the Treasury Borrowing Advisory Committee

April 30, 2024

Letter to the Secretary

Dear Madam Secretary,

Since the TBAC last met in late January, resilient domestic economic activity and stronger-than expected core inflation readings have led Treasury yields to rise by about 80 basis points. Aside from economic data and Fed policy, geopolitical developments also drove movements in asset prices over the period.

Six-month annualized core PCE inflation had slowed to 1.9% at the end of last year. But core PCE inflation in Q1 was stronger than expected at 3.7% annualized. Slower goods price inflation accounts for most of the disinflation in the last year with service sector inflation (both housing and non-housing related) proving "stickier."

Since January, Fed officials have guided in their post-meeting statement that policy rates will not be reduced until the Committee "has gained greater confidence that inflation is moving sustainably toward 2 percent." Chair Powell cautioned on April 16^th that the recently stronger inflation data mean "it's likely to take longer than expected to achieve that confidence." Markets, which had been pricing as much as 150bp of total rate cuts in calendar year 2024, are now implying just 30bp of cuts due to both stronger inflation data and resilient activity data.

Real economic activity and job growth have been stronger than most had projected. After growing 3.8% annualized in H2 2023, Q1 real GDP growth cooled to 1.6%, but with a still-solid 3.1% increase in private domestic demand. Growth has become increasingly dependent on stronger consumer services spending growth, with goods spending falling 0.4% in Q1. Business investment spending slowed to 2.9% in Q1 but with strong 13.9% growth in residential investment. Thirty-year fixed rate mortgage rates have once again increased beyond 7%, considered a headwind to the housing market.

Establishment survey job growth slowed over 2023 but has remained strong in 2024, with a three-month moving average of 276k as of March. The household survey has shown weaker employment growth, but the unemployment rate remains a historically low 3.8%. The labor force may have grown faster than expected in 2023 due to increased immigration, according to revised estimates from the Congressional Budget Office. Economists and other observers have expressed a range of views regarding how the inflow of workers might be affecting both economic fundamentals and officially reported economic data. Faster labor force growth and other positive supply-side factors can help reconcile stronger-than-expected growth with cooling inflation.

Rising tension in the Middle East led to acute risk-off dynamics on some days in April where oil prices rose, the US dollar strengthened and equity prices declined along with Treasury yields. But prices moved in an orderly manner as investors reacted to news. Oil and gasoline prices have increased since January but remain below their highs from last fall.

In March, Congress passed two appropriations bills for the remainder of the current fiscal year. This helped reduce uncertainty over the potential for a government shutdown in the near-term. A government shutdown had been a repeated risk over the previous six months with various continuing resolutions funding the government in short-term increments.

Regional banking stresses came in focus again with some banks citing losses on commercial real estate loans. Spillover risks to the broader banking system generally remained low. Immediate concerns over banking stresses have since subsided but could arise again in the future.

Fed officials continue to guide that balance sheet reduction is running on a separate track from interest rate policy and it is widely expected that the pace of reduction will slow this year. In a sign that liquidity is still abundant, short-term interest rates including SOFR have been well-behaved as balances in the Fed's reverse repo facility have declined from over $2 trillion one year ago to $534bln as of time of writing (though it dipped below $400bln earlier this month). As is typical, tax payments on April 15^th drained liquidity and reduced reserves to $3.3 trillion on the same day, the lowest level since November 2023, but still above the just-below $3.0 trillion last seen in February 2023.

Ten-year Treasury yields increased to 4.68%, but remain below the above-5% highs of last year. Most of the rise has been in real Treasury yields with ten-year TIPS yields rising from 1.56% to 2.28%. This reflects markets pricing a more extended period of higher policy rates and the potential that the longer term "neutral" real interest rate may now be higher. Longer-term inflation break evens have only moved modestly higher from about 2.2% to 2.4%.

In light of this fiscal backdrop, the Committee reviewed Treasury's May 2024 Quarterly Refunding Presentation. Based on the marketable borrowing estimate published on April 29, Treasury currently expects privately-held net marketable borrowing of $243bln in Q3 FY 2024 (Q2 CY 2024), with an assumed end-of-June cash balance of $750bln. The borrowing estimate is $41bln higher than announced in January 2024, primarily due to lower cash receipts, partially offset by a higher beginning-of-quarter cash balance. For Q4 FY 2024 (Q3 CY 2024), privately-held net marketable borrowing is expected to be $847bln, with a cash balance of $850bln assumed at the end of September.

Primary dealers slightly decreased their forecasts of private funding needs for FY 2024 while marginally increasing FY 2025. The FY 2024 move largely reflected dealers reducing their expectation for a mild recession this year. The light increase for FY 2025 was a function of dealers expecting the Fed's Quantitative Tightening (QT) program to last into the first half of 2025. In the near-term, dealers expected the Fed to reduce the SOMA runoffs starting between May and July, with a modal view of a June start. Most dealers expected the Treasury SOMA runoff cap to be reduced from $60bn/month to $30bn/month while the mortgage-backed securities caps would remain unchanged.

Turning to buybacks, dealers largely provided positive feedback around the test buyback operations. While Treasury will be limited to 20 CUSIPs in each operation initially, due to temporary settlement process limitations, the Committee supports Treasury's intention to expand when feasible. There were a few questions from the Committee on the process for publication of the results. A few members encouraged Treasury to expand buybacks over time to allow direct end-user participation, instead of through primary dealers. Dealers highlighted that Treasury should remain flexible with the buyback program depending on liquidity conditions and should not be price insensitive buyers. Overall, the Committee found the program details to be transparent and thorough, and feels the program will support Treasury's objective in supporting liquidity in the Treasury market.

The Committee then moved to review the two charges of the quarter. The first charge involved the transition of the 6-week cash management bill (CMB) to a benchmark T-bill. The presenting member highlighted that historically Treasury used CMBs for targeted, short-term needs such as around tax dates and debt limit impasses. Additionally, the presenting member noted that demand for T-bills remains strong and that clearing levels for the 6-week bill has remained well supported relative to other benchmarks. For example, Money Market Funds (MMFs) have increased their weighted average maturity (WAM) by roughly 20 days over the last year. It was highlighted that the 6-week bill provides a good liquidity vehicle for MMFs at various WAM levels in both tightening and easing cycles. There was some discussion noting that Treasury could look to expand its offerings of shorter dated debt, such as Floating Rate Notes (FRNs) to reduce rollover risk from increased reliance on short-dated T-bills. Ultimately, the Committee recommended transitioning the 6-week cash management bill to a benchmark. This move would reinforce Treasury's goal of 'regular and predictable' issuance by signaling these bills as part of its regular debt management process.

The second charge covered a "Blue Sky" investigation into new products and processes, similar to ones done in 2019 and in prior years. The framework used by the Committee in the discussion focused on four main objectives: minimizing Treasury's borrowing costs, expanding the investor base in Treasuries, enhancing market liquidity, and facilitating the management of Treasury's liability profile. The discussion first highlighted a product previously used by Treasury: callable bonds. The presenting member highlighted that the product has a large existing buyer base, given the significant outstanding issuance from other issuers. Some on the Committee felt that shorter-dated callables may be more attractive for Treasury due to an upward sloping OAS curve. There was also a discussion on how much of a premium Treasury would be expected to pay in coupon cost at time of issuance relative to the cost of volatility. The Committee discussed the extent to which it would be beneficial or practical for Treasury to hedge the embedded optionality in the product. The operational hurdles may constrain Treasury's ability to monetize the value for the taxpayer. It was noted that further evaluation would be needed to assess the products' usefulness more fulsomely.

The Committee also discussed the green bond market, which has relatively less dollar denominated issuance. The presenting member highlighted that other sovereign markets have issued some form of green bond, and that the product may bring in new foreign demand. Some members highlighted that possible challenges around the classification of such bonds and uncertainty around the possible premium ("greenium") a green bond issued by the Treasury may generate. There was also some uncertainty on how such bonds would interplay with the Treasury's regular and predictable issuance framework. The Committee highlighted that green bonds may bring in new demand for Treasuries and could warrant further study.

An expansion of existing products was also discussed such as both 1yr and longer-dated floating rate notes, a 3y TIPS benchmark, ultra long-end issuance and FRNs linked to Treasury note and/or bond yields. The Committee thought longer dated floaters beyond 2y, such as 3y and 5y should be further studied. A few members thought a 3y or 5y floater could see demand from bank portfolios, though they noted valuations would have to be competitive with asset swaps. The Committee generally agreed that there was demand for shorter dated TIPS, and that a shorter tenor benchmark could help achieve the recommendation of a 7-9% TIPS share. Most other options discussed were not viewed by the Committee to warrant further study at this time.

The Committee then turned to other debt management tools or processes which could be valuable. Topics such as tweaking the timing of Treasury settlements, considering reopening's and securities lending all gained some traction within the group. The concepts of reopening an existing CUSIP, or considering securities lending, both could be explored in the pursuit of supporting market liquidity, but further study would be needed.

In terms of issuance, the Committee recommended that Treasury keep nominal auction sizes unchanged for this quarter. Turning to TIPS, the Committee supported increasing the 5y and 10y TIPS auction by $1bn. While the T-bill share would be expected to remain slightly above the current 15 to 20% recommended T-bill range, on balance, the Committee felt this would best achieve Treasury's objective of minimizing cost to the taxpayer by operating in a regular and predictable framework. The Committee supported a return to the 15-20% range in the medium term, noting this may happen without further coupon increases. There were some members who felt the T-bill share recommendation could be revisited at a later date, given market developments and continued robust demand in the years since the original recommendation. Regardless, the Committee recognizes that it may be appropriate in the future to consider incremental increases in coupon issuance depending on how deficits are realized in the coming years.

Respectfully,

Deirdre K. Dunn

Chair, Treasury Borrowing Advisory Committee

Colin Teichholtz

Vice Chair, Treasury Borrowing Advisory Committee

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