In 2023, the Treasury increased the national debt by $2.6 trillion, and $2 trillion of it, accounting for 77%, came from short-term Treasury bills with maturity periods of less than a year. Normally, the Treasury utilizes medium-term debt to finance budget deficits. However, in 2023, there was a significant departure from this standard practice.
— Matt Davio (@MissTrade) January 27, 2024
The predominant use of bills as the primary source of funding only occurred twice before, during the Great Financial Crisis in 2008 and in 2020 during the Covid-19 pandemic. However, in neither of those years did bill issuance account for as much as 77% of the total new debt issued.
Over the past couple of decades, the Treasury has been striving to lengthen the maturity of its debt. The recent surge in short-term debt issuance has had the opposite effect, driving down the average maturity and necessitating more frequent rollovers of debt within shorter time frames.
So, what could be the reason for this shift in Treasury’s debt issuance strategy?
Treasury might be concerned about the market’s capacity to handle a significant amount of medium-term debt. While the market tends to absorb short-term debt smoothly, an excess of medium-term debt can overwhelm it.
Nearly $2 trillion was rolled over in the previous year. This implies that if the Treasury had chosen to issue notes instead of bills, the market would have had to accommodate a substantial $4 trillion in new medium-term debt, similar to what occurred in 2020. However, the key distinction this year is that in 2020, the Federal Reserve purchased nearly all of that debt, providing a safety net for the market.
There may be various reasons behind Secretary Yellen’s actions to ensure the stability of the financial system. One possibility is that she is determined to keep the Treasury market completely stable and is unwilling to take any risks. Consequently, she issues a significant amount of short-term debt, incurring an additional $30 billion cost to taxpayers this year, with plans to address the issue at a later time.
It is also possible that Secretary Yellen anticipates a substantial and rapid decline in interest rates.
It’s evident that everyone in Washington can understand that the Federal Reserve cannot smoothly lower rates on a gradual path. The only viable option is a significant reduction in interest rates, and Secretary Yellen appears to have placed a $2 trillion bet on this outcome.