Why Wall Street Is So Worried About ‘Refunds’

Investors this week have been fixated on a routine quarterly announcement on how the government plans to finance itself, a sign of how sensitive Wall Street has become to a rapid rise in interest rates.

On Wednesday, the Treasury Department said in its latest “repayment” announcement that it would issue an increased amount of short-term debt later this month. It had previously said it plans to borrow $776 billion in the last three months of the year, more than ever in the fourth quarter, to keep pace with government spending and rising interest payments.

The move is likely to be welcomed by investors, with a Treasury sector advisory group urging the ministry to keep short-term issuance at high levels as this could take some of the pressure off longer-dated bonds that support commercial rates light up. and have been bent in recent months.

The initial reaction on the financial markets was modest: shares rose and bond yields fell. Investors are still weighing in on the Fed’s decision on interest rates later on Wednesday, as well as key labor market data to be released on Friday.

The excessive attention to the Finance Ministry’s announcement comes as a sharp increase in interest rates has increased the cost of the national debt. The yield on 10-year U.S. Treasury bonds, which is indicative of what the government pays to borrow money over 10 years, has risen three-quarters of a percentage point since early August, the last time the Treasury Department informed markets of its borrowing plans.

That increase was partly related to investor fears about the government’s $33 trillion debt pile, especially given the cost of maintaining it now that the Federal Reserve has raised interest rates to a 22-year high. The federal deficit rose by $320 billion to $1.7 trillion through September 30. about half of that increase.

Ahead of Wednesday’s refund announcement, Ajay Rajadhyaksha, research chairman at Barclays, said the Treasury report marked “a defining moment for the markets,” anticipating that a move to issue more short-term notes and notes would be welcomed by investors who have had a difficult time. to absorb the recent sales of longer-term debt.

The Treasury Department said on Wednesday it would still increase the size of longer-term debt auctions – which was expected given the huge amount the government plans to borrow – but by slightly less than the Treasury’s Loan Advisory Committee, which consists of bankers and investors had recommended.

Benjamin Jeffery, rates strategist at BMO Capital Markets, said he expected the redemption announcement to take priority for investors over the Fed’s decision on interest rates, which will be announced later on Wednesday and will typically be the most prominent market event when this happens. happens.

“The market is very focused on repayment,” he said, noting that the August announcement had catalyzed the rise in yields.

The last time government borrowing costs were as high as they are today was in 2007. At the time, government debt was about 60 percent of GDP; now it is more than 100 percent.

Investors and analysts are concerned about who will step in to preserve government lending. Some major foreign investors, such as China, have already reduced their government bonds. Lower demand and increased supply of debt could push interest rates up even further.

“While there continues to be reasonable demand for U.S. Treasury securities from many domestic and international market participants, it has effectively not kept pace with the increase in supply,” the advisory committee report to the Treasury Department said.

The rapid rise in interest rates is not only being felt in government borrowing costs, as 10-year government bond yields also support corporate bond yields, consumer mortgages and many other types of debt around the world.

Investor concerns are compounded by the Fed’s Treasury downsizing, effectively removing the central bank as a buyer. And just as the Treasury Department pays higher interest rates to borrow, the Fed must pay higher interest rates on the money banks store at the central bank.

“The interest bill is only going one way in the coming years,” said Brad Setser, a senior fellow at the Council on Foreign Relations.

While the Treasury Department’s credit forecast is a record for the fourth quarter, it is still $76 billion less than expected three months ago, largely due to delayed tax revenues. It’s also less than the $1 trillion the government borrowed in the third quarter.

Alan Rappeport reporting contributed.