Translation: Peggy

Editor's Note: On August 19, the U.S. Treasury unexpectedly announced that it would increase the single-day liquidity support repurchase cap for 10-20 year and 20-30 year nominal Treasury securities from $20 billion to at least $40 billion, with the new arrangement set to take effect from September 9. Following the news, the long-end Treasury yields briefly declined by around 9 basis points, leading to a notable flattening of the yield curve.

However, the market quickly reverted to selling. The next day, the 10-year Treasury yield rose to 4.71%, and the 30-year yield approached its previous high. This prompted the market to question: if the repurchase size is relatively limited and has not yet been actually implemented, why did the Treasury choose to make an interim adjustment to the plan just two weeks after the quarterly refunding announcement?

ZeroHedge cited a report from J.P. Morgan's rate strategist Jay Barry, suggesting that the Treasury may not be addressing market liquidity dysfunction but rather expressing concerns about the rise in long-term yields. J.P. Morgan is genuinely worried not about the $40 billion repurchase itself, but whether the Treasury is deviating from "conventional and predictable" debt management principles to a more opportunistic approach to tenor and issuance management.

This distinction is crucial for the long-term pricing of Treasuries. If investors believe the Treasury is trying to suppress financing costs through repurchases or reducing long-dated supply without simultaneously improving the fiscal deficit, the temporary downward pressure on yields may not be sustainable. Instead, it may lead to an increase in term premiums, raising the cost of long-term borrowing.

Translation of the original text:

After the U.S. Treasury expanded its long-term Treasury bond repurchase, the market initially responded positively.

The Treasury announced that the single-day liquidity support repurchase cap for 10-20 year and 20-30 year nominal Treasury securities would be increased from a maximum of $20 billion to at least $40 billion. According to the Treasury's announcement, the new size will take effect from September 9, rather than entering the market immediately on the day of the announcement.

Following the news, long-end Treasury yields fell by about 9 basis points, and the yield curve also showed a similar level of flattening. However, this market trend did not last long. The next day, the 10-year Treasury yield rose to 4.71%, essentially reversing the post-announcement downturn.

JPMorgan Chase believes that the most noteworthy aspect of this repurchase adjustment is not the size, but the timing: the Treasury Department had just released a tentative repurchase schedule for the next three months in the August 5 quarterly refunding announcement, when the single-day repurchase limit for 10-20-year and 20-30-year bonds was still $20 billion.

Why Did the Treasury Department Increase the Size on Short Notice When the Market Was Functioning Normally?

US Treasury bond repurchases are mainly divided into two categories: cash management repurchases and liquidity support repurchases.

This adjustment targeted the latter. The Treasury Department repurchases less liquid off-the-run securities, i.e., bonds no longer from the most recent issuance, to improve the trading efficiency between different securities and provide market participants with predictable exit options.

Under this mechanism, the key consideration for increasing the repurchase size should typically be whether market liquidity is deteriorating.

Referring to the evaluation framework proposed earlier by the Treasury Borrowing Advisory Committee, JPMorgan Chase examined the repurchase auction sizes, the Treasury curve dislocation, and the valuation gaps between on-the-run and off-the-run bonds. The conclusion was that the relevant indicators for 10-20-year and 20-30-year bonds remained close to the average levels of the past year, showing no significant market dysfunction.

The report stated that the pricing bias of off-the-run bonds relative to the fitted yield curve has remained stable, significantly lower than the extreme levels of the past five years; the asset swap spreads between on-the-run and off-the-run bonds have not experienced significant dislocations. Overall, the operation of the US Treasury market this year has even improved.

Therefore, JPMorgan Chase interprets this temporary adjustment as a policy signal: the Treasury Department's concern may not be liquidity, but rather the long-term yield itself.

The Treasury Department Might Be Developing a New Long-End "Reaction Function"

JPMorgan Chase believes that there may be a common theme in recent policy actions—the Treasury Department showing increased sensitivity to rising long-term yields.

This involves a common market concept: reaction function, which is an informal rule where investors infer what actions policymakers may take under certain conditions based on their past statements and actions.

In JPMorgan Chase's view, the Treasury Department's decision to announce the repurchase adjustment a few hours before the 20-year bond auction and a day before the 30-year Treasury Inflation-Protected Securities auction may indicate its desire to alleviate long-end financing pressures. However, this is still an analyst's interpretation of policy intent, not a confirmed policy objective by the Treasury Department.

The report also points out that this year, U.S. bond yields have risen, with a significant portion of this move explained by the market's hawkish repricing of the Fed's policy path. According to J.P. Morgan's fair value model, the 10-year yield has not significantly diverged from fundamentals.

What has truly deviated is the longer end of the curve. Global long-term bond yields have generally risen, especially with the surge in Japanese long-term government bond yields, diminishing the relative attractiveness of U.S. bonds to some overseas investors.

During Japan's implementation of a negative interest rate policy and yield curve control, U.S. bond yields, after currency hedging, were more attractive than Japanese government bonds, helping to suppress U.S. long-end rates. Now, this mechanism is partially reversing: as Japanese long-term rates rise, it may reduce Japan's incentive to allocate funds to U.S. bonds and amplify upward pressure on the U.S. yield curve's longer end.

Repo Operations Address Symptoms, but Deficit Is the Core of Term Premium

J.P. Morgan's main criticism of the Treasury's strategy is that while repo operations can alleviate short-term pressures in the long-bond market, they cannot alter the fiscal backdrop of continuously increasing U.S. debt supply.

The report projects that the U.S. financing gap over the next several fiscal years could exceed $3.5 trillion. In this environment, the Treasury may ultimately need to offer more duration to the market, not less. Even if the Treasury reduces the size of long-bond auctions, it only shifts the funding requirement to other tenors without eliminating the overall borrowing need.

J.P. Morgan also notes that there has not been a collapse in demand at long-bond auctions. End-investor participation in 30-year Treasury bonds is at a record high for the year, and 20-year bond demand is also near a historical peak. This further weakens the argument that "temporary ramp-up through repos is necessary to improve market functioning."

The underlying issue remains the fiscal deficit. J.P. Morgan describes the current fiscal situation as a deficit of about 6% of GDP; the Congressional Budget Office's February baseline forecast for the 2026 fiscal year deficit is around $1.9 trillion, about 5.8% of GDP, with both estimates aligning closely.

The report suggests that without substantial fiscal consolidation, the market may view more flexible and opportunistic debt management as lacking credibility. Should the Treasury further deviate from "conventional and predictable" issuance practices, investors may demand a higher term premium to compensate for future supply, inflation, and policy uncertainty.

This implies that an operation aimed at lowering long-end rates may, in the long term, carry the risk of raising yields. However, this remains a risk scenario presented by J.P. Morgan rather than an outcome that has already occurred.

UK Experience: Adjusting Long-Bond Supply with Diminishing Impact

To assess whether the continued reduction in long-term debt supply can sustainably depress yields, J.P. Morgan referred to the UK experience.

The UK has lowered the proportion of long-term gilts to the net issuance from an expected 28.4% in April 2022 to the current 9.1%. Over the past four years, the UK DMO has adjusted the long gilt issuance share 12 times.

These adjustments often manage to flatten the yield curve in the short term. J.P. Morgan's analysis shows that in the five days following the announcement, the spread between UK 5-year and 30-year gilt yields narrows by an average of around 2 basis points; looking at a ten-day window around the announcement, the average reduction is around 5 basis points.

However, this impact is not enduring, and with repeated similar operations, each announcement's uplifting effect on long-end gilts gradually diminishes. Despite the UK base rate falling 175 basis points from its cyclical peak, long UK gilt yields remain near multi-decade highs.

Based on this assessment, J.P. Morgan believes that the US expanding repo or reducing long-dated issuance may also temporarily lower long-end yields but could struggle to alter the longer-term trajectory. Without a simultaneous narrowing of the fiscal deficit, structural supply adjustments are unlikely to serve as a sustainable tool for lowering funding costs.

Going forward, the market will need to observe not only whether the Treasury continues to increase repo sizes but also whether it trims the auction sizes of 20-year and 30-year bonds, and if there are substantive changes in the fiscal deficit, foreign demand, and term premium.

If long-end yields continue to rise post-repo actualization or if the market's reaction to each policy tweak becomes increasingly short-lived, it would bolster J.P. Morgan's view that "debt management cannot substitute fiscal rectitude." Conversely, if market liquidity metrics significantly deteriorate while repos continue to enhance trading efficiency, this adjustment is more likely to be deemed a technical operation rather than the Treasury's direct attempt to control long-term rates.