The US Treasury has raised its borrowing estimate for the July–September period to $1.01 trillion, almost double the earlier forecast of $554 billion. This increase follows the recent suspension of the debt ceiling, which allows for a $5 trillion uptick. To manage this, the Treasury is speeding up the issuance of bonds to rebuild its cash reserves, aiming for an $850 billion balance by the end of September. In the fourth quarter, borrowing is expected to drop to $590 billion.

Treasury Bond Issuance Strategy

Revenue from higher tariffs is adding extra funds, even though corporate tax receipts are expected to decline. The Treasury will provide details about its upcoming bond sales on Wednesday. We believe this significant rise in government borrowing will flood the market with new bonds, lowering their prices and raising yields. Derivative traders should get ready for a higher interest rate environment in the short term. This situation favors trades that benefit from rising yields, such as shorting Treasury futures. The 10-year Treasury yield has already risen above 4.2%, a level not seen in over 15 years, as markets start to account for this influx of supply. Historically, rapid increases in debt issuance have led to higher borrowing costs across the economy. We expect this trend to grow as new bonds are auctioned.

Impact on Financial Markets

This level of market absorption brings uncertainty, which we expect will increase volatility. The MOVE Index, a key measure of bond market volatility, has remained high throughout most of 2023, and we anticipate that this large issuance will lead to even more price fluctuations. It may be wise to buy options that benefit from this expected volatility. Higher returns on government debt can draw money out of the stock market, putting pressure on equity prices. We’ve already seen major indices like the S&P 500 pull back from their yearly highs as yields have risen in recent weeks. As a result, we are considering adding protective put options on equity indexes. A rise in U.S. yields can also attract foreign capital, which strengthens the dollar. The U.S. Dollar Index (DXY) has already gained over 2.5% since mid-July, and we see more upside as this borrowing plan moves forward. This makes long positions on the dollar against other major currencies look more appealing. With lower borrowing needs expected towards the end of the year, this intense pressure may be focused in the current quarter. Thus, while we should prepare for higher rates now, we need to be ready to reassess as we approach the fourth quarter. Market dynamics may change once this supply shock is absorbed. Create your live VT Markets account and start trading now.

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