Another date to put on your investing calendar: January 31.
That’s when the U.S. Treasury is scheduled to announced how it plans to finance the government’s huge revenue shortfall over the next three months. The betting on Wall Street is that the announcement will foreshadow a wave of new Treasury debt to be issued in 2018 that will double (at least) from 2017 to more than $1 trillion in net new issuance. That would be the most since 2010 when the Federal Reserve was buying Treasuries in order to jump start the economy after the global debt crisis. This time, of course, the Fed is a net seller Treasuries rather a buyer as it works to gradually reduce the size of its portfolio of Treasuries by not replacing some Treasuries it owns as they mature.
One key detail in the plan will be how the Treasury Secretary Steven Mnuchin distributes supply among short- to medium-term and long-term Treasury debt. An emphasis on issuing short- to medium-term debt is likely to lead to an even flatter yield curve in 2018–especially since the Fed has signaled its intention to raise short-term interest rates three times in 2018.
For the market to clear all this new supply, yields will almost certainly have to rise. (Overseas investors, governments and Central banks could step up, but the trend right now among these buyers is running toward reducing holdings of Treasuries.) Wall Street is now projecting that the yield on the 10-year Treasury will climb to 2.9% by the end of 2018 from 2.6% now. Yields are already up more than half-a-percentage point since September to the highest level since 2014. (And remember that bond prices fall as yields climb. For a $1,000 bond yielding 2.6% now to move to a yield of 2.9% the market price of the bond would have to fall to $897. That’s a drop of 10.3% in the price of the bond.)
The United States ran its biggest budget deficit since 2013 in the fiscal year that ended in September 2017. Even before the Tax Cuts and Jobs Act, the Congressional Budget Office projected that public debt would climb by more than $10 trillion by 2027. After the tax bill passed in December, JPMorgan Chase lifted its forecast for net new Treasury issuance in 2018 by about $100 billion to $1.42 trillion.
The best Wall Street guess now is that a big part of the new supply–$300 billion to $600 billion in 2018–will be in the form of Treasury bills–as soon as Congress raises or suspends the debt ceiling limit again that is. The rest would come through auction sales of longer maturities with the initial steps of the increase in maturities up to five years.
The Treasury plans to auction $26 billion of 2-year notes, $34 billion of 5-year notes, and $28 billion of 7-year notes this week.