Treasuries Rise as Fed Minutes Reveal Discussion of Pausing Balance-Sheet Runoff
(Bloomberg) -- US Treasuries rose after the minutes from last month’s Federal Reserve meeting revealed policymakers discussed pausing or slowing the balance-sheet runoff until the government’s debt-ceiling drama is resolved.
US government debt extended its advance on Wednesday, pushing policy-sensitive two-year yields lower by three basis points after the minutes. Officials in January talked about the potential need to consider pausing or slowing their balance-sheet runoff — a process known as quantitative tightening, or QT, which has been ongoing since June 2022 — until lawmakers can strike a deal to avoid exhausting their borrowing authority.
In particular, Fed policymakers cited the potential for significant swings in reserve balances over the coming months. System Open Market Account manager Roberto Perli cautioned those moves could become harder to gauge as the debt-limit situation “clouds the signals” provided by money-market indicators, and that extra cash banks stash at the Fed might decline quickly once a deal is struck.
After the release, yields across maturities fell by between one a and three basis points, steepening the yield curve. The 10-year yield fell to 4.53%, while swap spreads widened further.
The Fed has been winding down its holdings for almost three years, gradually increasing the amount of Treasury and mortgage bonds allowed to run off its balance sheet without being reinvested. The central bank’s assets peaked at $95 billion per month, and in June, it lowered the sum of Treasuries allowed to roll off. So far, the Fed has unwound more than $2 trillion from its balance sheet, leaving about $6.8 trillion in the System Open Market Account — well above the pre-Covid levels around $4 trillion.
Atlanta Fed President Raphael Bostic said later on Wednesday during an interview with Yahoo Finance it’s appropriate for policymakers to be more cautious about the balance sheet unwind going forward than they have in the past six or eight months.
While officials have said little about their future plans for the unwind until recently, the guidance is crucial for market participants who are wary of the risk that bank reserves become too scarce. Such a scenario stands to roil US funding markets and increases the threat of boosting borrowing costs as markets struggle to find buyers for new government debt issued to fund the swelling budget deficit.
“The key takeaway here is that there is potential for QT to stop slightly earlier than previously anticipated,“ said Gennadiy Goldberg, head of US interest rate strategy at TD Securities, whose firm expects the unwind to end in September. “This should be mildly bullish for Treasuries as it increases the risk that QT stops a bit earlier than currently expected, slightly decreasing Treasury issuance.”
Most Wall Street strategists have pushed out their expectations for when the Fed will end QT, with several forecasting a stop in the second half of 2025 — or even later. Fed Chair Jerome Powell said recently the balance-sheet unwind still has a ways to go.
Yet now that the Treasury Department has used up more than 70% of the extraordinary measures deployed to prolong its borrowing authority under the debt limit, and has started cutting bill supply and spending down its cash balance. The longer it takes Congress to either suspend or lift the limit, the more cash that will make its way back into the financial system, artificially boosting reserves and masking money-market signals that could indicate when it’s time to stop QT.
“The minutes show ‘contingency plans’ rather than a change in the baseline view,” Goldberg said. “This is the Fed preparing for the future.”
(Adds comments from Atlanta Fed President Raphael Bostic in sixth paragraph.)