Author: Wall Street News
Original Title: Will the "Big and Beautiful Act" Pass, Triggering a "Supply Flood" of Short-Term U.S. Treasuries?
With the Trump administration's massive tax cut and spending bill officially implemented, the U.S. Treasury may launch a "supply flood" of short-term government bonds to make up for future trillions of dollars in fiscal deficit.
The market has already begun to react to future supply pressures. Concerns about oversupply of short-term bonds are directly reflected in prices - the yield of 1-month short-term bonds has seen a significant increase since last Monday. This marks a complete shift in market focus from earlier concerns about selling 30-year long bonds to the front end of the yield curve.
With Trillions in Deficit Looming, U.S. Short-Term Treasury Market Faces "Supply Flood"
The new bill first brings a severe expectation of future fiscal conditions. According to calculations by the nonpartisan Congressional Budget Office (CBO), the bill will increase the national deficit by up to $3.4 trillion between fiscal years 2025 and 2034.
Faced with enormous financing needs, issuing short-term bonds has become a choice that is both cost-effective and preferred by decision-makers.
First, in terms of cost, while current one-year and shorter-term bond yields have risen to over 4%, they remain significantly lower than the nearly 4.35% issuance rate of ten-year bonds. For the government, lower immediate financing costs are highly attractive at a time when interest payments have become a heavy burden.
Second, this aligns with the clear preference of the current administration. Previously, President Trump himself has expressed a preference for issuing short-term notes rather than long-term bonds. Treasury Secretary Bessen has also told media that increasing long-term bond issuance at this point "makes no sense".
However, this strategy is not without risks. Relying on short-term financing may expose borrowers to future financing cost fluctuations or higher risks. An anonymous Canadian bond portfolio manager stated:
"Anytime you finance a deficit with extremely short-term notes, there's a risk of impact that could put financing costs at risk."
For example, if inflation suddenly rises and the Federal Reserve must consider raising rates, short-term financing costs would increase as Treasury yields rise. Additionally, economic recession and economic activity contraction could lead to reduced savings, thereby decreasing demand for short-term notes.
Supply vs. Demand: Can $7 Trillion in Liquidity Absorb the Bond Issuance Peak?
With the supply gates about to open wide, the market's capacity to absorb becomes a new core issue. Currently, the market seems confident, drawing strength from the massive liquidity accumulated in the money market.
Looking at the supply side, the U.S. Treasury Borrowing Advisory Committee (TBAC) currently recommends that short-term bonds should not exceed about 20% of total outstanding debt. However, Bank of America's interest rate strategy team predicts this proportion could quickly rise to 25% to digest new deficits. This means the market needs to be prepared to welcome short-term note supplies far beyond official recommended levels.
The market's focus has thus dramatically shifted. Just in April and May this year, investor anxiety was concentrated on the potential selloff of 30-year long-term bonds and the risk of yields soaring above 5%. Now, the spotlight has completely turned to another end: Will short-term bonds cause new turbulence due to oversupply?
On the demand side, Matt Brill, Head of North American Investment Grade Credit at Invesco Fixed Income, believes that the $7 trillion in money market funds represents "continuous demand" for front-end debt, a point the U.S. Treasury seems to recognize.
Mark Heppenstall, President and Chief Investment Officer of Penn Mutual Asset Management, is even more optimistic, stating:
"I don't think the next crisis will come from short-term bonds. Many people want to put capital to work, especially when real yields look quite attractive. You might see some pressure on short-term bond rates, but there's still a lot of cash moving in the market.
If a problem really occurs, the Federal Reserve will find a way to support any supply-demand imbalance."
