US Rates: Between a rock and a hard place

(upbeat music) You're listening to At Any Rate, JP Morgan's Global Research Podcast, where we take a look at the story behind some of the biggest trends in themes and fixed income, currency and commodity markets today. Good afternoon everybody, I'm your host, Jay Barrie, head of the Global Rate Strategy here at JP Morgan. So we're kind of in the eye of the policy storm right now. The FOMC met earlier this week on Wednesday and produce a volatility in US rates markets. But ahead of us lies another big policy event this time coming from the treasure department and the November refunding process, which kicks off on Monday afternoon, but then really the full slate of information will get is on Wednesday morning. And with me today to discuss this, because we think it's very important for considering what's happening in the US rates market is my colleague Amanda Burke. Welcome Amanda and let's just dig right in. - Yeah, thanks for having me Jay. Anytime, so on that note, let's talk first in the rear view mirror and look at what happened with the Fed this week. What did we learn and how does it affect our policy outlook given the developments on Wednesday afternoon? - Yeah, you know, we weren't expecting too many fireworks going into this one. Both we and the markets thought that the result would be a hold and that was what we got. There were two hawkish descents from President Hammock and Governor Lisa Cook. I would say of those two Cook was the more surprising considering she hasn't been as overtly hawkish in her public comments as some of the other presidents have been. So she was a bit of a new entrant into the hawkish wing of the party and of course she is a governor. She is also in the middle of her own situation with the White House who are trying to remove her as a governor and I'd say just overall it's a bit hard to read her vote here. The whole result was expected, but we also knew that the challenge was going to be how they explained holding when they hiked at the last meeting in a very similar inflationary environment. On that point, they added a sentence to the policy statement. They said the accumulation of more information will help the committee determine the policy stance appropriate to ensure a timely return of inflation to the committee's 2% goal. So that felt a little hawkish to us and taking all of that into account, we do still expect a hike at the next meeting in December. So there wasn't anything too exciting out of what we got at 2 p.m. but I would say what we got from Chair Warsh at 2.30 packed a bit more of a punch. Just to get the biggest thing out of the way first from that, Warsh announced that next year one full meeting will not have any policy decisions and will actually be focused instead entirely on broad and monetary policy strategy. In 2028, two meetings will have no decisions and will be focused on that. And that can really matter because it means that there will be a three-month gap potentially between meetings in some cases, which really means fewer chances to recalibate policy. Away from the scheduling news, I wouldn't say Warsh had much to say on the decision to hold itself. He did call the whole thing part of his policy of new monetary medicine. So we got a new entrance into his repertoire of analogies, which is kind of exciting, but beyond that, what I found interesting was that he really declined to endorse that sort of soft tightening bias that could be interpreted from the statement that I mentioned earlier. He also highlighted the evolution of financial conditions since the last meeting, which kind of brings back that idea that he first raised in July about long-term rates doing some of the Fed's work for them. And speaking of July, just like at that meeting, we saw a pretty decent market reaction here. So Jay, what I'd like to pick your brain on is, what was the market thinking watching all of what I just said? - Yeah, I think that's a great question, Amanda. And pretty interestingly, you've laid the groundwork for that the front end rallied. The curve twisted steeper with long end rates actually higher. And tips break even as wide. And so for me, as you said, I think there are some parallels to drive here or drive home here to the July meeting, although on a lower beta and a lower sensitivity than we saw in July. So in essence, against the backdrop of what you said, I read those reactions as markets certainly interpreting this as dovish and that makes sense. The chair's got to disdain for forward guidance and he didn't give us any chance to ratify the effective forward guidance that was in the statement. And second, you know, the flip side of it for the long end, we have long maintained that over a longer period, you can observe that volatility is a partial driver of term premium. And we would attribute that adjusting for rate levels to be a function of the increased transparency from the central bank with respect to policy communications over the last quarter century or so. So if you're starting to unwind that with fewer meetings where you'll get policy statements and press conferences, even though one can argue that the relevance to monetary policy from the chair's press conference from our own NLP is pretty limited, that would suggest that over time, if this is going to meet in higher volatility out the curve, it should mean higher term premium as well. So I think that's how we can sort of perceive the steepeting that we've seen right there. But it was again, a little bit more contained than what we saw in July. And just very interesting that it's almost like you have the chair course correcting at every meeting right now. The markets came in and June expecting him to be credibly dovish. And then he was on the margin hawkish and we bearishly flattened. Just the reverse happened in July. Then he had to course correct once again in Jackson Hole and in September. And now he's kind of gone back. So he's kind of zigging where the markets are zagging here. But in essence, we expected the risks would be slightly toward the dovish side and the curve steepening sort of aligns with that. So I think that captures the Fed movements very well. And that's been the broad preponderance of the moves that we've had this week. A lot of that steepening occurred on Wednesday. If we can pivot from Fed to Treasury and you've done a lot of work ahead of the November with funding announcement, what are our expectations from Treasury next week, both with respect to guidance, issuance, and buybacks? Yeah, so as always, we'll get the financing estimates first on Monday and then a full announcement on Wednesday. The funny thing is, since the last refunding on the fiscal level, not that much has actually changed here, and with most of Congress is actually focused on campaigning ahead of the midterm elections. So we haven't learned much new on the financing front. And our deficit expectations for a fiscal year 2027 are unchanged at 1 spot 96 trillion. So with that in mind, just from a hard numbers perspective, we expect 2 spot 038 trillion in net privately held borrowing in calendar year 2026 in total, and 2 spot 202 trillion in calendar year 2027. Once you net out Fed purchases and buybacks, that means we'll see $401 billion in privately held outstanding change this year, and $991 billion in calendar year 2027, which would actually make that the heaviest year for Bill issue in since 2023. So a lot of bills coming next year. On the back of that, we see $475 billion in net marketable borrowing in this quarter, assuming an end of cash, a quarter cash balance of $850 billion, and $664 billion in net marketable borrowing next quarter, assuming an end of quarter cash balance of $1 trillion. So those are the hard numbers. And those numbers leave us with the same picture we've known sort of what's coming for quite a while, which is a growing funding gap from here as maturities pick up. And from that perspective, just coming back to the actual or funding announcement itself, we really think that the most prudent thing for Treasury to do would be to remove at least from the longstanding for guidance that anticipates maintaining nominal coupon and FRN auction sizes for at least the next several quarters. So that's what we think Treasury should do from a prudent demand-adventure perspective. But we do have to keep in mind that Treasury was hesitant to update that guidance last quarter. And instead, they actually tweaked the line of for guidance that it would evaluate potential future increases to nominal coupon and FRN auction sizes to instead say future changes. And we really saw that as Treasury opening up ambiguity in a distribution of outcomes, which would lessen bearish pressures on yields. Treasury also made a surprise announcement to upside its long-end buyback program just two weeks later, despite the fact that we really didn't see anything in Treasury's stylized buyback score, which was actually custom built specifically for this purpose to evaluate the need for changes to the program. We didn't see anything in that model that would suggest that this was needed. And the through lines for those actions was Treasury's really discomfort with level of yields, which has been the case since the summer. So we actually expect Treasury to maintain the next several quarters language into 2027. And we expect Treasury to maintain the current level of current auction sizes through August 2027. At that point, we would expect Treasury to begin a multi-quarter series of increases, which would be concentrated in the two to 10-year sector of the curve. So that's what we expect. But of course, that may not be what we get on Wednesday, which leads me to ask you, Jay, hearing all of that, what do you see as in major risks we should be watching out for here? - Yeah, I think you've couched it well, Amanda. Like there could be a gap between what is Treasury's most likely course of actions and what could happen. And the point that you made the buyback announcement a bit more than two months ago, I think raises the probability of something more intervention is happening. And the reason I say that I think just off the top of my head, I can think about four events over the last quarter century or so where the Treasury has announced something on debt management strategy outside the confines of the quarterly refunding. There was one back in the beginning of 2020 when it gave us months advance notice that it would be bringing back the 20-year bond. There were a couple of times in, I believe it was October and or November of '08, when it had to snap, re-open a couple of securities because I think there was collateral transfer. in various places in the aftermath of the failure of women brothers, and then there was this. And because of that, we have to take it very seriously with the upsides to the buybacks. And given the observed, and I think implied, discomfort with the level of long-end rate levels, we have to think that there is a risk that treasury could actually make bigger adjustments to its debt management strategy in fact cut long-end auction sizes. And I think since the dealer questionnaire came out just a few weeks ago, markets have been looking at the question treasury asked about the longer-term outlook for demand and how it should adjust at the issuance schedule. I think investors and market participants have been trying to draw through line as you say there as well. We think this line of questioning is more medium-term in nature. There's no doubt there's reduced demand for longer duration assets. And that over time, this is a not just a US story, but global phenomenon as well, and that you would probably need to rely less on long-term issuance. But given the bigger funding gap that you talked about just before, probably makes more sense to not cut access to the long end, which has actually been serving you quite well. So nevertheless, I think given this discomfort, the risk would be that there would be a cut-to-long return auction size. Isn't it least temporarily that's something that would lower long end yields and flatten the yield curve? And I think the reason I say that is as we've talked about before, there's evidence of other developed market debt management offices have done this. We can look to the UK's DMO or the bank, excuse me, the Japanese Moff. And that has temporarily lowered long-term yields and flatten the yield curve. But unless this is accompanied by some sort of fiscal consolidation announcement, we think it would likely be more temporary than nature. And if it highlights the likelihood that treasury has to rely more on the intermediate sector over time, it just means we should probably squeeze the term premium into the belly of the curve. So that's the big risk to this. The other thing that I'm finally saying you were a part of the piece that we published on this just last night is the treasury, as you said, is likely to lean heavily on tea bills next year as well. But what we've noticed is that due to a confluence of factors, bills have cheapened up quite significantly in the last number of weeks and are trading cheap to sofa for the first time in a couple of years. And while we do think some of the demand dynamics are likely to be more temporary in nature coming from the foreign community, we think you're past the most heady days of money market fund AUM growth and that's likely to retrace closer to the growth rate of the economy itself. So if that's a case in tea bills are going to be the lever that's pulled for the most of the net issuance or about half of the net issuance for next year, the risk is that bills can just say structurally cheaper. And if that's the case, they're probably not as attractive an instrument as they have been in the last number of years. So this is a long-winded way of me saying there is a significant risk that we see cuts to long end auction sizes, even though we don't think that's the best course and that if that were to occur or that could drive yields lower. But as we've been saying, I think there's already an observed premium in the market for this because when I look at the slope of the treasury curve at the long end, call it 10s 30s, typically over shorter and longer horizons, its predominant driver is the medium term policy outlook for the Fed. And given where medium term Fed policy expectations are right now, that curve slope looks five or six basis points to flat and that gap has been there for a few weeks right now. So perhaps if you don't get that sort of shift from the treasury department, there's a risk that the curve steepens more than what's implied by short end rates here. So I think we've covered a lot of ground here over the last 15 or 20 minutes Amanda, both in the rear view mirror of what happened on the Fed and the implications for the treasury curve and then the look forward to next week with respect to the treasury department thinking about policy on both side of the equation. And I think this is a perfect place to leave it here. So thanks everybody for listening today and stay tuned for more episodes at any rate, which is again JP Morgan's Global Research Podcast series. This communication is provided for information purposes only. Please read JP Morgan research reports related to its contents for more information, including important disclosures. Copyright 2026, JP Morgan Chase and Co. All rights reserved. This episode was recorded on October 30th, 2026.