Treasury refunding preview: T-Bill, t-storm

The federal budget deficit is projected to reach $1.75 trillion in FY2025 and exceed $2 trillion by FY2026-27, though increased tariff revenues are expected to offset near-term widening, mitigating the risk of an immediate 'fiscal blowout.' Quantitative tightening is forecast to continue through year-end, with bank reserves bottoming around $2.78 trillion by mid-2026, albeit with risks skewed towards a longer QT period. Critically, Treasury's issuance strategy has evolved, now anticipating coupon auction sizes to remain unchanged through year-end 2026, shifting the burden of meeting borrowing needs increasingly onto T-bills, with projections indicating a potential $1 trillion in net T-bill issuance in 2027 if coupon increases are further deferred.

Analysis

The U.S. fiscal outlook presents a mixed picture of near-term stability against a backdrop of medium-term challenges. Federal budget deficits are projected to widen significantly, reaching $1.75 trillion in FY 2025 and escalating to $2.10 trillion by FY 2027. However, an anticipated surge in tariff revenues is expected to buffer this expansion, reducing the immediate risk of a disruptive "fiscal blowout." Concurrently, the Federal Reserve's policy path involves continuing quantitative tightening (QT) through the end of the year, with bank reserves forecast to bottom out around $2.78 trillion in mid-2026. A pivotal development is the revised Treasury issuance strategy; contrary to previous expectations, coupon auction sizes are now anticipated to remain unchanged through year-end 2026. This policy shift places a substantial financing burden on short-term T-bills, with projected net issuance of $475 billion in Q3 and $416 billion in Q1-2026. Consequently, the T-bill share of outstanding debt is expected to climb to 22.5% by year-end 2027, creating a scenario where, absent coupon increases, net T-bill issuance in 2027 could reach an unprecedented $1 trillion to meet borrowing needs.

Key Decisions for Investors

• Consider positions that benefit from a flatter yield curve, as the Treasury's reliance on massive T-bill issuance while holding coupon auctions flat is likely to place upward pressure on short-term yields relative to the long end.
• Closely monitor bank reserve levels and money market spreads for any signs of funding stress, given the base case for quantitative tightening to continue through year-end with risks skewed toward a longer duration.
• Re-evaluate duration exposure, as the delay in coupon auction size increases until at least February 2027 may provide temporary support for longer-dated bond prices, but be prepared for a significant supply event when issuance eventually ramps up.
• Given the projected deficit trajectory, investors should factor in a potential increase in issuance volatility and higher long-term financing costs for the U.S. government beyond the current 2026 forecast horizon.