The US Treasury signaled on Wednesday that it will continue relying heavily on ultra-short-term debt issuance to meet the government's growing borrowing needs, despite increasing warnings about the risks of this strategy. In its quarterly debt policy statement, the Treasury stated it expects to keep auction sizes for nominal notes and bonds unchanged "at least over the upcoming quarter." The department believes the current auction sizes allow it to respond effectively to potential changes in the fiscal outlook and fluctuations in the Federal Reserve's purchases of Treasury securities.

Since the beginning of 2024, the US debt management office has maintained the same forward guidance, a policy that has steadily increased the proportion of Treasury bills—debt with maturities of one year or less—within the total outstanding debt. Last month, the International Monetary Fund warned that this approach, due to more frequent auctions, makes federal debt costs more vulnerable to sudden interest rate swings and shifts in market sentiment.

The Treasury also reiterated that it is monitoring "strong demand from private investors for Treasury bills" alongside the Fed's purchasing pace. Furthermore, it repeated that it continues to study the possibility of increasing sales of nominal coupon-bearing securities and floating-rate notes in the future, focusing on "structural demand trends and the potential costs and risks of various issuance compositions."

While dealers widely expected the Treasury to maintain current auction sizes, opinions were divided ahead of the so-called "quarterly refunding" report on whether guidance might be revised. Massive US budget deficits make an eventual expansion of longer-term bond auctions almost inevitable. The department raised its net borrowing estimate for the current quarter on Monday, citing lower net cash flows.

Treasury Secretary Bescent has largely retained the forward guidance inherited from predecessor Janet Yellen, despite previously criticizing it before taking office. Last year, he noted that higher yields on longer-term securities made expanding issuance of such debt unattractive. "Bescent is not looking to rock the boat by changing the quarterly refunding schedule," said Win Xin, Chief Economist at Nassau 1982 Bank. Nevertheless, US Treasuries face "multiple supply risks" over the long term.

The upcoming refunding auctions next week, totaling $125 billion, will consist of: - May 11: $58 billion in 3-year notes - May 12: $42 billion in 10-year notes - May 13: $25 billion in 30-year bonds The Treasury stated this refunding will raise approximately $41.6 billion in new cash.

In a separate statement, the Treasury Borrowing Advisory Committee, a panel of bond investors, dealers, and market participants, suggested that increasing coupon-bearing security sales in the fiscal year starting in October might be justified. The panel "discussed potential changes to forward guidance for the Treasury's consideration."

Prior to the announcement, the Treasury surveyed bond dealers on the impact of several financial regulatory easing measures on the government debt market. Feedback indicated that "while these developments are positive in direction, the marginal benefits are expected to be limited," according to a TBAC report. The TBAC also said it "welcomed the opportunity" to provide further input on the market impact of potential regulatory changes.

Federal regulators finalized revisions to the so-called enhanced supplementary leverage ratio in November, allowing large US lenders to hold less capital relative to total assets. In March, regulators released additional proposed packages related to other rules.

Wall Street banks have long argued that regulations limit their ability to act as intermediaries in the Treasury market, especially during periods of stress. There are signs these changes may be having an effect; Morgan Stanley CFO Sharon Yeshaya said last month that it has allowed the bank to provide more liquidity to the bond market.

A major new source of demand for Treasury bills is the Federal Reserve, which increased its purchases in December to ensure ample reserves in the banking system. Although the pace of purchases has slowed from $40 billion to $25 billion per month, the Fed is also now reinvesting proceeds from maturing mortgage-backed securities into Treasury bills. Combined, this adds hundreds of billions of dollars in annual demand that the Treasury does not need to fill from the private sector.

The Treasury said it expects to increase the sizes of shorter-dated benchmark bill auctions in the coming weeks and will issue one short-term cash management bill by the end of May "to address the peak in liquidity needs at the end of May resulting from the maturity of coupon-bearing securities." The debt management office anticipates bill auction sizes will "modestly decrease" in June, before gradually increasing again in July.