Wall Street’s biggest bond dealers are starting to forecast that the U.S. Treasury will reduce the size of its debt auctions in coming months for the first time in three years as government revenue soars.
With the Congressional Budget Office estimating a 2013 budget deficit of $845 billion, the smallest since 2008, eight of the 21 primary dealers who trade with the Fed say Treasury may cut the amount of notes it offers that are due in five years or less as soon as July. The government hasn’t trimmed coupon auctions since 2010, a year after the economy began expanding from the worst financial crisis since the Great Depression.
Limiting the supply in a market where investors are bidding about a record $3 for every $1 of debt sold may force buyers to pay more for Treasuries at a time when demand for short-term debt has pushed yields on one-month bills below zero. The dealers’ outlook has shifted in response to a growing economy amid rising tax revenue and cuts to government spending.
“The rapidly shrinking deficit means we aren’t going to need as many Treasury bonds as we would if the deficit hadn’t been shrinking so quickly,” Edward Keon, portfolio manager and managing director of Newark, New Jersey-based Quantitative Management Associates LLC, a unit of Prudential Financial Inc., which manages $95 billion, said in a May 9 telephone interview. “There is still a very strong demand for high-quality fixed- income product on a global basis.”
Smaller Auctions
Smaller-than-forecast deficits may give the U.S. enough leeway to make it through to the end of the fiscal year on Sept. 30 without breaching the debt ceiling, which Congress suspended until May 18, according to Morgan Stanley economist Ted Wieseman. That would take pressure off President Barack Obama and lawmakers as they try to craft a budget that addresses longer- term fiscal imbalances.
Treasury, which has sold $32 billion of three-year notes each month since October 2010, may reduce the July offering of the securities to $31 billion, Thomas Simons, an economist in New York at primary dealer Jefferies Group LLC, said in a telephone interview May 6. That would be followed by $1 billion less in sales of two- and five-year notes later that month, he said.
Mizuho Securities USA forecasts cuts will begin in August for those securities, as does Morgan Stanley, which also expects the seven-year note offering will shrink by $1 billion in September followed by similar reductions to 10-year notes and 30-year bonds in October. Bank of Nova Scotia, Barclays Plc, BNP Paribas, Citigroup Global Markets and RBC Capital Markets forecast the smaller auctions will begin in the fourth quarter.
Eleven firms forecast no cuts in issuance this year, and Daiwa Securities Group Inc. and Goldman Sachs Group Inc. didn’t make projections.
Bond Yields
Yields on 10-year Treasuries, the benchmark for everything from corporate bonds to mortgages, rose to as high as 1.93 percent on May 10, the most since March 26.
Returns on U.S. bonds have averaged an 4.9 percent annually during the past five years, with the 10-year yield falling to 1.86 percent from 3.77 percent during that period even as outstanding Treasury debt has soared to $11.4 trillion from $4.7 trillion, according to Bank of America Merrill Lynch bond indexes.
The Treasury said May 10 that the U.S. posted a monthly budget surplus of $112.9 billion in April, the widest in five years. Revenue rose 28 percent to $406.7 billion while spending increased 13 percent to $293.8 billion. The deficit for the first seven months of the fiscal year ending Sept 30 shrank 32 percent, to $487.6 billion from $719.9 billion in the same period in 2012.
Treasury View
CBO forecasts show the deficit falling to $616 billion, or 3.7 percent of gross domestic product next year, and then to $430 billion in fiscal 2015. It peaked at $1.42 trillion, or 10 percent of GDP in 2009.
“Depending on how the fiscal situation develops, Treasury may decide to gradually decrease coupon auction sizes,” the department said in a statement May 1.
Barclays lowered its deficit projection to $750 billion from $850 billion May 10, while Morgan Stanley reduced its forecast to $775 billion from $860 billion, before accounting for $89.5 billion in payments by Fannie Mae and Freddie Mac to the government this year.
“The deficit improvement has been so much ahead of schedule,” Morgan Stanley’s Wieseman said in a May 9 telephone interview. “Changes that we were expecting in issuance later this year needed to be shifted forward just by the positive surprise on the budget outlook.”
Bill Sales
The Treasury may adjust sales of short-term bills while waiting to see if the budget deficit continues to contract, according to the 11 dealers forecasting no change in issuance.
While deficits are falling now, they will resume growing in coming years as government retirement and medical costs rise, according to the CBO, which forecasts a $798 billion shortfall in 2020.
“Down the road deficits begin to increase again,” William Marshall, an interest-rate strategist at Credit Suisse Group AG in New York, said in a May 6 telephone interview. “Even if the Treasury were to reduce coupon issuance in the next few years, it would quickly find itself needing to boost issuance again due to redemptions and rising deficits.”
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