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Treasurys Gain, Curve Flattens After Refunding Auction Sizes Remain Unchanged

When previewing today's FOMC announcement, we said that at least according to some, this morning's refunding announcement may have a bigger impact on the market as there is less consensus (and more confusion) about what would be unveiled. As JPM analyst Jay Barry told Bloomberg, the quarterly refunding announcement at 8:30am ET Wednesday “has the possibility to be a bigger event for markets in the morning than the Fed statement in the afternoon” as participants are divided on whether the Treasury will announce increases to coupon auction sizes Wednesday, or wait until the 1Q refunding announcement in February:

“There’s a dispersion of views because of the pivot the Treasury Department has had over last few years,” specifically toward portfolio metrics and aiming to extend the weighted average maturity of the portfolio. Merely reversing the cuts that have been made to 2Y and 3Y auctions since 2013 wouldn’t serve that objective. “If they don’t get announced tomorrow, it’s a muted rally, and if they do, it’s a muted steepening.”

Furthermore, as Bloomberg summarizes, going into today's announcement, market participants were divided leading into the announcement with most seeing no increase immediately to auction sizes just yet, seeing only bill auction changes for now: Barclays, NatWest, Bank of America, Credit Agricole, Jefferies, Stone & McCarthy Research Associates and Citigroup all saw no change; JPMorgan Chase, among other, looked for small increases across maturities.

Well, moments ago the US Treasury reported the breakdown of the refunding auctions, which led to Treasuries promptly paring some early losses (and leading to the predicted muted curve flattening) after the Treasury Department maintained its coupon auction sizes over the next three months, while the refunding statement did not comment on ultra-long issuance.

Specifically, the Treasury announced a $62.0 billion Refunding package this morning, unchanged from recent Refundings. The Refunding auctions will consist of a $24.0 billion 3-year note, a $23.0 billion 10-year note and a $15.0 billion 30-year bond. Treasury has held the 3-year note auction size steady at $24.0 billion since the beginning of 2015, and the 10-year and 30-year Refunding auction sizes steady since February 2016.

However, while Treasury said again this morning that they will not change the size of nominal coupon auctions during the quarter ahead, they did note that the beginning of the Fed's balance sheet roll-off means they expect to announce "gradual adjustments" to nominal coupon and 2-year FRN auction sizes at the February Refunding. While the sizes of those changes remain to be decided, they expect the result will be that the weighted average maturity of debt outstanding will stabilize around current levels, "with the caveat that unexpected large changes in borrowing needs could have an unforeseen impact on future issuance and ultimately the level of WAM."  To wit:

Given the announced changes to the Federal Reserve’s reinvestment policy for its System Open Market Account (SOMA) portfolio and projections for the fiscal outlook, in addition to increasing bill supply, Treasury anticipates announcing gradual adjustments to its nominal coupon and 2-year FRN auction sizes at the February 2018 refunding.  The magnitude and allocation of increases to auction sizes will depend in part on projections for the fiscal outlook, as well as feedback from market participants.

 

Based on current fiscal forecasts and internal Treasury modeling, it is anticipated that these changes will likely result in a stabilization of the weighted average maturity (WAM) of debt outstanding at or around the current levels, with the caveat that unexpected large changes in borrowing needs could have an unforeseen impact on future issuance and ultimately the level of WAM.  Any adjustments will be made in a manner consistent with our practice of being regular and predictable.

The take home for the market, however is that the TSY punted on the decision for rising auction sizes, saying it plans to address changes in any seasonal borrowing needs over the next quarter through changes in regular bill auction sizes and/or cash management bills.

As Bloomberg details, the Treasury said given Fed balance sheet unwinding plans, it “anticipates announcing gradual adjustments to its nominal coupon and 2-year FRN auction sizes at the February 2018 refunding.” These changes are anticipated to result in “a stabilization” of the weighted average maturity of debt outstanding at or around the current levels; while unexpected large changes in borrowing needs could have an “unforeseen impact on future issuance ultimately.”

The TBAC minutes also signaled an increased issuance in 2-, 3-, 5-year sector “is attractive” and added that extraordinary measures will allow the government to continue to meets its payment obligations through January 2018,

The Treasury concluded that "it is currently too early to provide a more precise forecast as to how long the extraordinary measures will last" and, perhaps most importantly, the Treasury did not comment on study of issuing ultra-long bonds in quarterly refunding statement.

And an interesting note at the end of the TBAC minutes:

Treasury believes that it is prudent to regularly test its contingency auction infrastructure.  Treasury’s contingency auction system has been used routinely over the last several years to conduct mock auctions.  Within the next quarter, Treasury intends to conduct a small-value test auction using its contingency auction system. More details about this small-value auction test will be announced at a later date. This small-value auction should not be viewed by market participants as a precursor or signal of any pending policy changes regarding Treasury’s existing auction processes.