The US Federal Reserve (Fed) has moved mountains to control inflation, which fell below 3% for the first time since 2021 in July. Unfortunately, the Fed works at cross purposes with the US Treasury, whose debt-issuance strategy has provided backdoor interest-rate cuts, keeping inflation above the Fed’s target range.
The Treasury has delivered economic stimulus equivalent to a one-point cut in the Fed’s policy rate by shortening its issuance profile to reduce long-term interest rates. Moreover, forward guidance in the Treasury’s latest quarterly refunding announcement indicates that this backdoor quantitative easing (QE) will continue to frustrate the Fed’s efforts and compromise its functions.
Typically, the Treasury aims for 15% to 20% of outstanding debt to be in short-term bills, with the rest in intermediate- and long-term debt, called coupons. But this share has risen and remains well above any reasonable threshold: as much as 70% of new debt raised over the last year came from short-term bills, pushing the total well above 20%.
Such an excessive reliance on short-term debt is generally reserved for times of war or recession when markets are fragile and financing needs spike. Yet the past year has been one of buoyant equity markets, above-target inflation and strong growth. Investors understandably have begun to question whether the Treasury’s issuance strategy is still “regular and predictable,” lawmakers such as Senators Bill Hagerty and John Kennedy have taken notice and begun to confront Treasury Secretary Janet L. Yellen about the issue.
In a recent Hudson Bay Capital research paper, we describe the current policy as an “Activist Treasury Issuance” (ATI) case and consider its broader economic consequences. Like activist monetary policy, activist issuance deviates from the standard rules and influences the broader economy through its effect on interest rates. Not only does the ATI work through the same channels as the Fed’s QE programs, but it was engineered in part by the former Fed officials who now run the Treasury.
Whereas bills are economically similar to the base money created by central banks, coupons bear significant interest-rate risk. When investors absorb more of this risk, they are less able to hold other risky assets like stocks. Thus, when the supply of bonds goes down, bond prices go up, pushing other asset markets higher through what economists call the “portfolio balance channel”.
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While QE hides bonds away on the Fed’s balance sheet and gives investors money in their place, an ATI reduces the creation of bonds at the source, giving investors more “money-like bills” instead. The results are similar: lower yields and juiced-up asset prices stimulate the economy.
We calculate that ATI has reduced coupon issuance by more than US$800 billion ($1 trillion), delivering a degree of stimulus similar to a 100-basis-point reduction in the Fed’s policy rate. Put another way, the Treasury has effectively offset all the Fed’s 2023 interest-rate hikes. Additionally, the ATI has been supplemented with forward guidance — another favourite Fed tool — indicating that it will persist to the other side of this year’s US election for a few quarters.
Given the higher estimates of neutral policy rates, the current issuance and interest-rate policies do not constrain the economy. As the Treasury hinders the Fed’s efforts to control inflation and growth, it is not surprising that both metrics have consistently remained above target.
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If the ATI is not quickly reversed, it may become a permanent policy tool because both parties want to use it to stimulate the economy ahead of elections. We will have entered a world of politicised business cycles, where policy stimulus is synchronised with the polls. This prospect is disturbing for the same reasons as threats to central bank independence.
To unwind its ATI, the Treasury must retire US$1 trillion worth of excess bills. This would temporarily (for a few years) raise long-term yields by 0.5%, but these yields would ease to a permanent 0.3% rate, with an attendant repricing of risk assets. The cooling effect on the economy would be similar to a two-point Fed policy rate hike.
The Treasury’s issuance strategies have boosted the economy before an election but hindered the Fed’s attempts to control inflation. This approach risks creating political business cycles with persistently high inflation and interest rates. The Treasury should resume regular and predictable issuance as soon as possible. — © Project Syndicate
Nouriel Roubini, a senior adviser at Hudson Bay Capital Management LP and Professor Emeritus at New York University’s Stern School of Business, is the author, most recently, of Megathreats: Ten Dangerous Trends That Imperil Our Future, and How to Survive Them (Little, Brown and Company, 2022). He is a former senior adviser at the US Treasury (1999-2000). Stephen Miran, Senior Strategist at Hudson Bay Capital, is a former senior adviser at the US Treasury (2020-21)
