How might markets react to a deluge of U.S. government bond issuance?

Executive summary:

  • Key risks to markets from expected wave of U.S. Treasury bill issuance include illiquidity concerns and banking-sector stresses
  • Reserve Bank of Australia surprises investors again with rate hike
  • U.S. equity and bond markets remain rangebound

On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and ESG and Active Ownership Analyst Zoe Warganz discussed potential market implications of the anticipated wave of U.S. government bond issuance. They also covered the latest rate hikes by central banks in Australia and Canada, and provided a recap of recent performance in equity and fixed income markets.

Key market risks from expected influx of U.S. Treasury issuance

Warganz and Eitelman began by discussing the expected flood of Treasury bill issuance, which Eitelman noted is necessary to replenish the Treasury Department’s cash account, which has sunk to a level of about $50 billion. Normally, the Treasury prefers to keep around $600 billion in this account, Eitelman said, explaining that the government had to draw down its cash balance significantly in order to keep paying its bills while the debt-ceiling negotiations played out.

“Now that the issue has been resolved, the Treasury Department will need to raise a lot of money to refill its coffers. Consensus expectations are that the government will need to issue around $850 billion in Treasury bills by the end of September,” he stated. Eitelman added that while this amount of issuance isn’t unheard of, it is fairly unusual and typically only happens during times of crisis, such as in 2020 and 2008. With that, there are a couple risks around the expected wave of debt issuance, he said.

The first risk is that because most of this money will be raised in short-term funding markets, there’s a possibility some funding markets could become illiquid and strained, Eitelman said. Because of this, it’s reasonable to expect that Treasury bill yields might trade in excess of U.S. Federal Reserve (Fed) expectations that are embedded in overnight index swaps, he noted.

The second risk centers around where this money will come from—in other words, who will buy the massive amount of Treasury bills, Eitelman said. “There’s a possibility that it could come out of bank deposits—out of people’s banking accounts. This could create more problems for banks, because if they all of a sudden face deposit outflows again—like back in March—that could place additional pressures on what’s an already strained sector,” he stated.

By and large, however, investors are well-aware of these risks, Eitelman remarked. “In my experience, usually when this is the case, the market impact tends to be small—but it’s definitely worth keeping an eye on,” he concluded.

Australian and Canadian central banks announce unexpected rate hikes

Shifting to the latest headlines around global central banks, Warganz noted that both the Reserve Bank of Australia (RBA) and the Bank of Canada (BoC) caught markets off guard the week of June 5 with 25-basis-point (bps) rate hikes. Eitelman agreed that neither rate hike was excepted by investors, and explained that central bankers in both countries are clearly still worried about persistent inflationary pressures.

In his opinion, the RBA’s rate hike was probably the most surprising, as it marked the second time in a row that the Australian central bank surprised investors with an increase in borrowing costs. “As a result, investors are now pricing in more rate hikes, with many anticipating two additional increases this year,” Eitelman stated, adding that this is creating some upward pressure on Australian fixed income markets.

Noting that the Fed’s next policy meeting is June 13-14, Warganz asked Eitelman if the U.S. central bank could follow the RBA in surprising investors with a rate increase. Eitelman said he doesn’t think this will be the case, as the Fed typically errs on the side of trying not to surprise investors. He added that Fed Governor Philip Jefferson strongly hinted recently that the central bank will forgo a rate increase at this meeting.

Our expectation is that the Fed will announce a pause on rate hikes,” Eitelman stated, adding that he’ll be closely monitoring the meeting and ensuing press conference for forward guidance on U.S. monetary policy.

Recapping recent equity and fixed income market performance

Warganz and Eitelman concluded the segment with a look at recent performance in equity and fixed income markets. Eitelman said that as of market close on June 8, the S&P 500® Index was on track to finish the week of June 5 relatively flat, with equities largely remaining rangebound. He noted, however, that under the surface, it’s been an interesting year for the U.S. equity benchmark, with much of the gains in the index driven by seven large mega cap tech companies. Excluding these companies, the rest of the U.S. equity market has traded closer to flat on worries over an economic slowdown, Eitelman commented.

He said that U.S. fixed income markets were also fairly calm the week of June 5, with 10-year Treasury yields only up about 2 bps through June 8. Bond markets were more active outside of the U.S., Eitelman noted, especially in Australia and Canada, due to the unexpected rate hikes. “This was especially the case in Australia, where the yield on the 10-year government bond rose to nearly 4%—the highest it’s been in several months,” he concluded.

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