Economists such as Roubini have recently accused the U.S. Treasury Department of improperly manipulating U.S. Treasury bond auctions and artificially controlling the size of long-term bonds.

Under the expectation of the Federal Reserve's interest rate cut, the U.S. Treasury market has rebounded recently. At the same time, the yield curve of 2-year and 10-year U.S. Treasury bonds has been inverted since early July 2022, setting a record for the longest and deepest inversion in history.

On Wednesday (July 31st), the U.S. Treasury will announce a quarterly refinancing plan for long-term securities, which is expected to be the latest factor affecting the trend of U.S. Treasury bonds. Just before the announcement of the plan, some market participants, including "Dr. Doom" Nouriel Roubini, accused the U.S. Treasury of manipulating the U.S. Treasury market by deliberately lowering long-term bond yields and raising short-term bond yields.

Longest streak of gains in three years

U.S. Treasuries have continued to rise recently as the Federal Reserve is expected to signal the start of a rate cut cycle in September at this week's meeting. Data shows that the recent rally has boosted a key indicator of U.S. Treasuries, the Bloomberg U.S. Treasury Index. A monthly increase of 1.3% would mark the third consecutive month of gains, the longest streak in three years, and would push the cumulative increase since the end of April to about 3.9%.

Traders in the U.S. interest rate swap market currently expect the probability of the Fed cutting interest rates at least twice by the end of 2024 to be 97.6%, the probability of cutting interest rates at least three times to be 61.8%, and the probability of cutting interest rates in September to be 100%. Last week, former New York Fed President William Dudley once called for a rate cut in July, but this expectation was quickly offset by the U.S. second quarter GDP data, and many market participants believed that the Fed should avoid cutting interest rates in advance and scaring the market. The interest rate swap market expects that the probability of a rate cut this week is only 5.2%.

Wells Fargo macro strategist Erik Nelson said: "The U.S. bond market has already digested the expectation of a rate cut in September. The next question is, can the Fed cut interest rates twice in the future? I think it certainly can. In my opinion, the question that the market should be more concerned about is whether this round of rate cuts can be accumulated six or more times."

Goldman Sachs economist David Mericle expects the Fed's interest rate announcement to revise its wording, indicating that based on economic data, Fed policymakers are "feeling increasingly comfortable and pressure-free" about the idea of starting a rate cut.

Kate Moore, head of strategy at BlackRock, believes: "Fed policymakers are in a very difficult situation and they want to remain cautious, especially before the election." Even so, "we still stand in the camp of the first cut in September and expect three rate cuts in 2024 and another rate cut in the first half of 2025." She said that this is because "we expect the United States to face more disinflationary pressures later this year."

Yield curve inversion hits longest, deepest point in history

But the U.S. Treasury market is not all good news. While the U.S. Treasury bond market is set to record its longest consecutive rise in three years, the inverted yield curve of U.S. Treasury bonds has caused market participants to worry.

The 2-year and 10-year Treasury yield curve has been inverted since early July 2022, surpassing the record set in 1978. The inversion occurred after the Federal Reserve began a rate hike cycle in March 2022 to curb inflation. In recent weeks, the curve has steepened due to the combined effects of the "rate cut trade" and the "Trump trade", that is, the spread between 2-year and 10-year Treasury yields has narrowed. Data from electronic trading platform operator Tradeweb showed that the spread hit negative 14.5 basis points last Wednesday, the smallest inversion since July 2022.

Now, as the inversion is about to end, some market participants have warned that this indicates the risk of a shrinking U.S. economy. In their view, the spread has turned from inversion to positive again because the economic slowdown has led the market to expect the Federal Reserve to cut interest rates, causing the increase in short-term bonds to exceed that of long-term bonds.

"In recent cycles, the end of the yield curve inversion and re-steepening usually occurs shortly before a recession, so it needs to be closely watched," Deutsche Bank strategist Jim Reid said in a report last week. In every case investigated by Deutsche Bank, the yield curve steepened again before the recession began. In addition, according to an analysis report released by Deutsche Bank last year, in the past four recessions (2020, 2007-2009, 2001 and 1990-1991), the yield spread between 2-year and 10-year U.S. Treasury bonds turned positive when the recession occurred. The interval between the reversal of the yield curve inversion and the start of the recession varies, ranging from about 2 to 6 months. George Cipolloni, portfolio manager at Penn Mutual Asset Management, also said: "We are at an important node now, because now the yield curve has steepened again from inversion, which is usually when we will get into trouble."

But some analysts believe that this indicator is not reliable. Lawrence Gillum, chief fixed income strategist at LPL Financial, an independent economic trader in the United States, said: "Some indicators may not be as perfect as historical data show. At present, the reduction in the inversion of the yield curve is not due to the risk of economic recession, but just a return to a normal upward-sloping yield curve."

New quarterly refinancing plan attracts attention

In any case, after a period of rebound, this week's latest quarterly refinancing plan is seen as an important factor affecting the subsequent trend of U.S. Treasuries because it will affect the supply of U.S. Treasuries. After the U.S. Treasury was accused of manipulating the U.S. Treasury issuance strategy, this plan has also attracted more attention.

Although the Federal Reserve sets interest rates directly, the U.S. Treasury can influence interest rates through the timing and size of bond auctions and the maturity of auctioned bonds. Economist Nouriel Roubini, known as "Dr. Doom," and Stephen Miran, a Treasury official during Trump's term, recently accused the U.S. Treasury of improperly manipulating U.S. Treasury auctions, artificially controlling the size of long-term bonds, and choosing to use short-term bond issuances such as Treasury bills to solve additional funding needs in a commentary published by Hudson Bay Capital. In their view, this is part of the Democrats' intentional efforts to lower long-term bond yields before the election to stimulate the economy and help the Democratic Party's election.

"By adjusting the maturity of debt issuance, the Treasury is dynamically managing financial conditions and thereby managing the economy. This is usurping the core functions of the Federal Reserve. We call this new tool Aggressive Treasury Issuance (ATI). By manipulating the interest rate risk held by investors, ATI operates through a mechanism equivalent to the Federal Reserve's quantitative easing." According to their calculations, "ATI has lowered the 10-year Treasury yield by about 25 basis points over the past year, providing an economic stimulus similar to a 1 percentage point cut in the federal funds rate. This offset the Fed's rate hikes in 2022-2023." They also added that "ATI has prevented the Fed's attempts to curb inflation, which explains why inflation has persisted over the past year and why the nominal growth rate has unexpectedly risen." In response, U.S. Treasury Secretary Yellen said last Friday that the Treasury Department "did not use such a strategy" to try to loosen finance.

Regardless, the U.S. Treasury did slow its long-term bond issuance starting last November in favor of short-term notes. The latter has climbed as a share of total outstanding debt and recently exceeded the 15% to 20% range previously recommended by the Treasury Borrowing Advisory Committee (TBAC), an external group of investors, dealers and other market participants. TBAC said there was "flexibility" in the recommended range. TBAC's initial recommendation was made in 2020, when rising short-term interest rates helped drive demand for short-term notes. Jay Barry, co-head of U.S. interest rate strategy at JPMorgan Chase, said the Treasury and TBAC may revisit the 15% to 20% framework at some point.

Against this backdrop, U.S. bond investors are now paying close attention to whether the Treasury will further increase the size of its long-term bond auctions this week or in the future . In May, the U.S. Treasury said that the already high size of bond and note auctions would be sufficient "at least for the next few quarters" and that it intended to keep the size of U.S. medium- and long-term Treasury auctions stable in the coming quarters. Some market participants therefore expect that the refinancing plan announced this week is expected to maintain the May model, that is, to issue a total of $125 billion in 3-year, 10-year and 30-year securities, including $58 billion in 3-year bonds on August 6, $42 billion in 10-year bonds on August 7, and $25 billion in 30-year bonds on August 8.

Citigroup strategist Jason Williams predicts: "The Treasury will not change its previous guidance now because they can continue to use short-term bills to address additional funding needs." He added that it makes sense for the Treasury to rely more on short-term bills because they will benefit from the Fed's rate cuts.

But some Wall Street institutions, including Barclays, Bank of America and Goldman Sachs Group, believe that the Treasury may revise the guidance in light of worsening deficit forecasts. Barclays expects the Treasury's note issuance to increase by a net $600 billion in 2024 and slow to $300 billion in 2025. "In the short term, the Treasury does have a solution, which is to issue more short-term notes," said Meghan Swiber, U.S. interest rate strategist at Bank of America. "But the Treasury could still change the wording in its guidance on Wednesday, suggesting that it may have to consider increasing the size of long-term bond auctions again in the coming quarters."

Some market participants also said that releasing the possibility of increasing the scale of long-term bond issuance to the market now will help mitigate the negative impact when it is really necessary to do so in the future. Anshul Pradhan, head of US interest rate strategy at Barclays, said that considering the deficit situation, the US Treasury may "ultimately still need to significantly increase the scale of long-term bond issuance in the future. We believe that the prudent approach is to adjust the guidelines in advance and do a good job of ex ante expectation management for the gradual increase in future issuance."

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