Why Wall Street Is So Worried About ‘Refunding’

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

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

The move is likely to be welcomed by investors, with an industry advisory group to the Treasury urging the department to keep short-term issuance at high levels because it could help relieve some of the pressure on longer-dated bonds, which underpin commercial interest rates and have buckled in recent months.

The outsized attention on the Treasury Department’s announcement comes as a sharp rise in rates has pushed up the cost of government debt. The benchmark 10-year Treasury yield, indicative of what the government pays to borrow money for a decade, has risen by three-quarters of a percentage point since early August, the last time the Treasury Department updated the markets on its borrowing plans.

That rise was partly linked to investors’ fears about the $33 trillion debt pile the government has built up, especially given the cost of maintaining it now that the Federal Reserve has raised interest rates to their highest levels in 22 years. The federal deficit increased $320 billion, to $1.7 trillion, for the year through Sept. 30. Rising interest costs represented roughly half of that increase.

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

The Treasury Department said on Wednesday that it would still increase the size of longer-dated debt auctions — which was expected given the sheer amount the government is planning to borrow — but by slightly less than the Treasury borrowing advisory committee, which is made up of bankers and investors, had recommended.

Benjamin Jeffery, an interest rates strategist at BMO Capital Markets, said he expected the refunding announcement to take precedence for investors over the Fed’s decision on interest rates, set to be announced later on Wednesday and typically the most prominent market event when it happens.

“The market is very focused on refunding,” he said, noting that August’s announcement had catalyzed the move higher in yields.

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

Investors and analysts worry about who will step up to keep lending to the government. Some large foreign investors, like China, have already pared their Treasury holdings. Lower demand and more supply of debt could push interest rates even higher.

“Effectively, while there is still reasonable demand for U.S. Treasuries from many domestic and international market participants, it has not kept pace with the increase in supply,” the advisory committee’s report to the Treasury noted.

The swift ascent of yields is not only felt in government borrowing costs, since the 10-year Treasury yield also underpins the rates on corporate debt, consumer mortgages and many other types of debt around the world.

Adding to investors’ worries is the shrinking of the Fed’s Treasury holdings, effectively removing the central bank as a buyer. And just as the Treasury Department is paying higher interest rates to borrow, the Fed must pay higher interest on the money that banks store at the central bank.

“The interest bill is only going one direction for the next few years,” said Brad Setser, a senior fellow at the Council on Foreign Relations.

While the Treasury Department’s borrowing forecast is a record for the fourth quarter, it is still $76 billion less than it had expected three months ago, largely because of delayed tax receipts. It is also less than the $1 trillion borrowed by the government in the third quarter.

Alan Rappeport contributed reporting.