Janet Yellen’s approach to managing debt carries significant risks.
The Biden administration’s spending habits have led to significant increases in borrowing, resulting in trillion-dollar deficits during a time of economic stability and peace. However, the magnitude of Treasury issuance is just one factor in U.S. borrowing. Understanding how the U.S. borrows is crucial for market assessments of American financial credibility.
In the United States, the primary method of funding has typically been through the issuance of medium-term notes and long-term bonds. The Treasury Department typically avoids attempting to predict market timing and instead focuses on issuing notes and bonds in a consistent and reliable manner. This approach facilitates the establishment of structured benchmark interest rates and enables markets to strategically manage the substantial interest-rate risk associated with longer-term Treasury securities. This contributes to the overall stability of the market.
Typically, Treasury bills have accounted for around 15% to 20% of the total outstanding stock of debt. During economic downturns, the percentage of bills typically rises alongside the deficit, driven by the demand for safer assets and the need to ensure a steady and predictable issuance of notes and bonds. That’s the reason why bills increased from around 15% of outstanding debt in February 2020 to 25% by May 2020. The government was attempting to secure funding for its Covid response amidst an economic downturn. As the economy rebounded, debt management reverted to conventional methods, with bills decreasing to less than 20% of outstanding debt by July 2021, despite the significant spending of the American Rescue Plan.
In 2023, the Treasury Department made a significant increase in bill issuance, resulting in bills’ share of outstanding debt rising from around 15% at the start of the year to approximately 22%, which is the current level. Due to this change, Treasury Secretary Janet Yellen decided to issue over $1 trillion in bills instead of the usual notes and bonds.
By gradually issuing bills, financial conditions were effectively eased as the amount of interest-rate risk that markets would have had to handle through higher note and bond issuance was reduced. During the fourth quarter of 2023, the market observed a decrease in note and bond issuance, which had a notable impact on 10-year Treasury yields. Starting from just under 5% in November 2023, the yields gradually declined and ended up below 4% by the end of December 2023. This contributed to a significant increase of over 25% in stock prices, which had a positive impact on the overall economy. In light of the projected $1 trillion deficit for 2024, it is worth noting that the Treasury Department has recently stated its intention to maintain current issuance levels for the next few quarters. This decision conveniently ensures that there won’t be an influx of notes and bonds in the market leading up to the November election.
However, the immediate boost in sugar consumption has a considerable impact on taxpayers. The recent relaxation of financial conditions has sparked renewed inflationary pressures, which could potentially necessitate further economic measures to alleviate. Due to the inverted yield curve, the government will face higher interest expenses as they are forced to renew short-term financing at higher rates instead of securing lower long-term rates. If long-term interest rates are indeed higher due to deglobalization and other macroeconomic trends, Ms. Yellen’s decision will have a greater negative impact on taxpayers.
The erosion of norms regarding prudent public debt management poses a significant threat. The credibility of the Treasury secretary is crucial for the functioning of markets. With Ms. Yellen’s departure from traditional Treasury issuance practices and adoption of a risky new strategy that prioritizes market benefits before the election, investors are having to adapt. As a result, borrowing costs across the curve are expected to increase, which will further weaken the U.S. fiscal position.
Mr. Katz has an extensive background in economics, with experience as an adjunct fellow at the Manhattan Institute and a senior adviser at the U.S. Treasury Department from 2019 to 2021.
