Wall Street Speculates: What’s Scott Bessent’s Next Move to 'Rescue' U.S. Debt?

Original Title: "Wall Street Speculates: What’s Scott Bessent’s Next Move to 'Rescue' U.S. Debt?"
Source: Wall Street Journal

Wall Street is focusing on the quarterly debt issuance plan on November 4, viewing it as a significant unknown. Deutsche Bank expects to expand the scale of long-term bond repurchases, exceeding the $4 billion cap; Morgan Stanley anticipates an increase in the issuance of short-term Treasury bills and short-term debt; Citigroup has listed the reduction of 20-year Treasury auctions as a tail risk and postponed expectations for large-scale auctions until 2028. U.S. Treasury Secretary Scott Bessent has adopted a more proactive strategy in national debt management, a shift that is disrupting the long-standing predictability of the U.S. bond market and prompting Wall Street to urgently simulate potential significant adjustments in government borrowing strategies over the coming months.

According to Bloomberg on August 26, with the announcement last week of a bond repurchase plan referred to by Bessent as the "Treasury twist," the market's focus has quickly shifted to the Treasury's quarterly debt issuance plan on November 4. Strategists from Wall Street investment banks like Bank of America and Deutsche Bank have warned that for the $31 trillion U.S. Treasury market, this upcoming announcement has become an unprecedented unknown.

Currently, mainstream institutions on Wall Street expect that the Treasury may signal in November that future borrowing increases will be accomplished through short-term Treasury bills and shorter-term notes, while further expanding the scale of repurchases to alleviate pressure on long-term yields. Some investment banks even point out that the likelihood of directly reducing the issuance of long-term bonds is increasing.

As long-term Treasury yields hover at multi-year highs, the Treasury's deviation from the long-standing practice of being "regular and predictable" is injecting new volatility into the market. Investors are facing a new era of U.S. debt management and are reassessing the risk exposure of their portfolios accordingly.

November Debt Issuance Plan Becomes a Market 'Unknown'

Bessent's recent actions have broken the long-standing calm in U.S. policymaking. Meghan Swiber, Managing Director of U.S. Interest Rate Strategy at Bank of America Corp, stated that the bond market is entering "a whole new world of U.S. debt management."

Although Bessent has currently ruled out changes to the regular auction plan and stated that the Treasury will adhere to the current schedule at least until the next debt issuance plan is announced, market expectations have already changed.

Ian Lyngen, Head of U.S. Interest Rate Strategy at BMO Capital Markets, pointed out that Bessent's actions have effectively turned the November debt issuance announcement into a huge unknown. He emphasized that the possibility of reducing the scale of bond auctions can no longer be ruled out.

Additionally, the Treasury made subtle wording adjustments in its recent debt issuance guidance, indicating that officials are assessing potential "changes" in future coupon and floating rate note sales, rather than the previous guidance of "increases." Analysts believe that this provides more room for the Treasury to reduce long-term bond issuance.

Strategies of Expanding Repurchases and Shortening Duration

Reports suggest that as a first step in adjustments, the Treasury may focus on repurchase operations. A team of strategists led by Steven Zeng at Deutsche Bank believes that the Treasury may raise the scale of long-term operations above the initially suggested minimum of $4 billion.

Officials may even keep the scale of operations confidential until the day before the operation, thereby reducing the predictability of the repurchase plan and significantly raising the threshold for investors to short long-term Treasuries.

However, expanded repurchase operations alone are unlikely to achieve a substantial change in the government debt maturity profile. Unlike the Federal Reserve, the Treasury cannot create funds out of thin air to finance its purchases. This means that repurchases must ultimately be funded through additional issuance (most likely short-term Treasury bills) or cash from the Treasury's accounts.

Morgan Stanley noted that the Treasury account could provide $80 billion to $200 billion in funding for repurchases.

Morgan Stanley interest rate strategist Martin Tobias stated that the expanded repurchase itself may only be a transition until the November debt issuance plan is released. He believes that the event that will ultimately trigger market volatility will be the Treasury's method of shortening the weighted average maturity.

Tobias expects the Treasury to gradually increase the sale of shorter-term notes while maintaining stable sales of longer-term bonds, but the risk of directly reducing long-term bond auctions has increased over the past week.

Tail Risks and Controversies of Reducing Long-Term Bond Issuance

Some strategists are considering more aggressive reform proposals.

Citigroup has postponed its forecast for larger-scale auctions until 2028 and raised the tail risk that the Treasury may ultimately cancel the 20-year Treasury bond. This maturity bond was reintroduced by former Treasury Secretary Steven Mnuchin under the Trump administration in 2020.

Despite its shorter maturity, the current yield on the 20-year Treasury bond is similar to that of the 30-year Treasury bond, which seems illogical against the backdrop of an upward-sloping U.S. yield curve.

Jason Williams, Head of U.S. Interest Rate Strategy at Citigroup, stated that given the poor trading performance of the 20-year Treasury bond relative to the 10-year and 30-year Treasury bonds, the Treasury is likely to reduce its auction scale, and the 20-year Treasury bond may benefit the most from future actions.

However, reports indicate that directly reducing long-term bond issuance faces real challenges. The Treasury stopped selling 30-year Treasury bonds in 2001, but the fiscal context at that time was entirely different, with budget surpluses reducing the government's financing needs. In the current period of high issuance, any move to cancel a specific maturity bond would force other maturity bonds to absorb that borrowing.

Kevin Flanagan, Head of Investment Strategy at WisdomTree, warned that reducing issuance at the long end of the curve and compensating elsewhere seems mathematically very difficult. He stated that if the Treasury goes down this path, the market will view it as manipulation, which could ultimately backfire.

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