With the formal implementation of Trump's large-scale tax cut and spending bill, the U.S. Treasury may unleash a "flood" of short-term Treasury supply to cover the upcoming multi-trillion-dollar fiscal deficits.

The market has already begun to react to the anticipated supply pressure. Concerns over an oversupply of short-term Treasuries have directly translated into price movements—the yield on one-month short-term Treasuries has risen significantly since last Monday. This marks a shift in market focus from earlier concerns about the sell-off in 30-year long bonds earlier this year to the front end of the yield curve.

Trillion-Dollar Deficits Looming, Short-Term Treasury Market Faces a "Supply Flood"

The implementation of the new bill first brings a grim outlook for future fiscal conditions. According to estimates by the nonpartisan Congressional Budget Office (CBO), the bill will add as much as $3.4 trillion to the U.S. national deficit between fiscal years 2025 and 2034.

Faced with such a massive financing need, issuing short-term Treasuries has become a choice that is both cost-effective and favored by policymakers.

First, in terms of cost, although the yield on one-year and shorter-term Treasuries has climbed above 4%, it remains significantly lower than the nearly 4.35% issuance rate of 10-year Treasuries. For the government, which is already burdened with heavy interest payments, the lower immediate financing cost is highly attractive.

Second, this aligns with the clear preference of the current administration. Previously, President Trump himself had expressed a preference for issuing short-term bills over long-term bonds. Treasury Secretary Besant also told the media that increasing the issuance of long-term bonds at this juncture "makes no sense."

However, this strategy is not without risks. Relying on short-term financing could expose borrowers to the risk of future fluctuations in financing costs or even higher costs. An anonymous Canadian bond portfolio manager said:

"Any time you finance a deficit with extremely short-term bills, there is a risk of a shock that could put financing costs at risk."

For example, if inflation were to rise suddenly and the Federal Reserve had to consider raising interest rates, the yield on Treasury bills would increase, raising the cost of short-term financing. Additionally, a recession and a contraction in economic activity could lead to a reduction in savings, thereby reducing the demand for short-term bills.

Supply vs. Demand: Can $7 Trillion in Liquidity Absorb the Bond Issuance Peak?

With the supply floodgates about to open wide, the market's absorption capacity has become the new core issue. Currently, the market seems to be confident, drawing strength from the vast liquidity piled up in the money markets.

On the supply side, the U.S. Treasury Borrowing Advisory Committee (TBAC) currently recommends a cap of around 20% for short-term Treasuries as a proportion of total outstanding debt. However, Bank of America's interest rate strategist team predicts that, to absorb the new deficit, this proportion may soon climb to 25%. This means the market needs to prepare for a supply of short-term bills far exceeding the official recommendation level.

The market's focus has also shifted dramatically. Just in April and May of this year, investors' anxieties were centered on the sell-off in 30-year long-term Treasuries and the risk of their yields surging above 5%. Now, the spotlight is entirely on the other end: whether short-term Treasuries will cause new turmoil due to oversupply.

On the demand side, Matt Brill, the North American Investment Grade Credit Head at Invesco Fixed Income, believes that the $7 trillion in money market funds in the market have a "continuous demand" for front-end debt, and the U.S. Treasury seems to be aware of this.

Mark Heppenstall, President and Chief Investment Officer of Penn Mutual Asset Management, is even more optimistic. He said:

"I don't think the next crisis will come from short-term Treasuries. Many people want to put their capital to work, especially when real yields look quite attractive. You may see some pressure on short-term Treasury rates, but there is still a lot of cash flowing in the market.

If there really is a problem, the Fed will find a way to support any supply-demand imbalance."

With the formal implementation of Trump's large-scale tax cut and spending bill, the U.S. Treasury may unleash a "flood" of short-term Treasury supply to cover the upcoming multi-trillion-dollar fiscal deficits.

The market has already begun to react to the anticipated supply pressure. Concerns over an oversupply of short-term Treasuries have directly translated into price movements—the yield on one-month short-term Treasuries has risen significantly since last Monday. This marks a shift in market focus from earlier concerns about the sell-off in 30-year long bonds earlier this year to the front end of the yield curve.

Trillion-Dollar Deficits Looming, Short-Term Treasury Market Faces a "Supply Flood"

The implementation of the new bill first brings a grim outlook for future fiscal conditions. According to estimates by the nonpartisan Congressional Budget Office (CBO), the bill will add as much as $3.4 trillion to the U.S. national deficit between fiscal years 2025 and 2034.

Faced with such a massive financing need, issuing short-term Treasuries has become a choice that is both cost-effective and favored by policymakers.

First, in terms of cost, although the yield on one-year and shorter-term Treasuries has climbed above 4%, it remains significantly lower than the nearly 4.35% issuance rate of 10-year Treasuries. For the government, which is already burdened with heavy interest payments, the lower immediate financing cost is highly attractive.

Second, this aligns with the clear preference of the current administration. Previously, President Trump himself had expressed a preference for issuing short-term bills over long-term bonds. Treasury Secretary Besant also told the media that increasing the issuance of long-term bonds at this juncture "makes no sense."

However, this strategy is not without risks. Relying on short-term financing could expose borrowers to the risk of future fluctuations in financing costs or even higher costs. An anonymous Canadian bond portfolio manager said:

"Any time you finance a deficit with extremely short-term bills, there is a risk of a shock that could put financing costs at risk."

For example, if inflation were to rise suddenly and the Federal Reserve had to consider raising interest rates, the yield on Treasury bills would increase, raising the cost of short-term financing. Additionally, a recession and a contraction in economic activity could lead to a reduction in savings, thereby reducing the demand for short-term bills.

Supply vs. Demand: Can $7 Trillion in Liquidity Absorb the Bond Issuance Peak?

With the supply floodgates about to open wide, the market's absorption capacity has become the new core issue. Currently, the market seems to be confident, drawing strength from the vast liquidity piled up in the money markets.

On the supply side, the U.S. Treasury Borrowing Advisory Committee (TBAC) currently recommends a cap of around 20% for short-term Treasuries as a proportion of total outstanding debt. However, Bank of America's interest rate strategist team predicts that, to absorb the new deficit, this proportion may soon climb to 25%. This means the market needs to prepare for a supply of short-term bills far exceeding the official recommendation level.

The market's focus has also shifted dramatically. Just in April and May of this year, investors' anxieties were centered on the sell-off in 30-year long-term Treasuries and the risk of their yields surging above 5%. Now, the spotlight is entirely on the other end: whether short-term Treasuries will cause new turmoil due to oversupply.

On the demand side, Matt Brill, the North American Investment Grade Credit Head at Invesco Fixed Income, believes that the $7 trillion in money market funds in the market have a "continuous demand" for front-end debt, and the U.S. Treasury seems to be aware of this.

Mark Heppenstall, President and Chief Investment Officer of Penn Mutual Asset Management, is even more optimistic. He said:

"I don't think the next crisis will come from short-term Treasuries. Many people want to put their capital to work, especially when real yields look quite attractive. You may see some pressure on short-term Treasury rates, but there is still a lot of cash flowing in the market.

If there really is a problem, the Fed will find a way to support any supply-demand imbalance."