By Lindsay Dunsmuir and Karen Brettell
WASHINGTON/NEW YORK (Reuters) - The U.S. Treasury on Monday said it expects to borrow $56 billion more during the third quarter than previously estimated, and market participants expect shorter-dated Treasuries to absorb the brunt of the new supply as the Trump administration grapples with a mushrooming budget deficit.
The federal government is ramping up bond issuance to cover a budget hole fueled by big spending increases and falling corporate tax receipts. It also has to fill gaps left as the Federal Reserve cuts its massive bond portfolio.
The Treasury Department said in a statement that it expects to issue $329 billion through credit markets during the July-September period, assuming an end-September balance of $350 billion. It also forecast $440 billion of borrowing in the final three months of the year.
The borrowing estimate for the third quarter is the highest since the same period in 2010 and fourth largest on record for the July-September quarter, according to a senior Treasury official. In the second quarter, net borrowing totaled $72 billion.
Social security costs, military spending and debt service expenses are all on the rise at the same time as corporate tax income is declining after last year's tax reforms. As a result, the U.S. fiscal picture is darkening, with the federal budget deficit expected to reach $833 billion this year, up from $666 billion in the budget year ended last September, according to the Treasury's June budget report.
“Because of surprising declines in corporate tax revenues, the federal deficit is constantly under discussion this month,” said Jim Vogel, an interest rate strategist at FTN Financial in Memphis, Tennessee.
The Fed is also trimming the vast holdings of Treasury debt that it accumulated to help foster the recovery from the 2007-2009 recession, adding to the supply of bonds hitting the market.
SUPPLY BULGE AT FRONT OF CURVE
The Treasury on Wednesday will detail how it expects to spread the new supply across bond maturities ranging from one month to 30 years.
Bond market participants expect faster increases in maturities out to five years, which could push their yields up at a quicker pace than those for longer-dated securities, which should see less of a supply increase.
The Treasury is expected to increase sales of two-year (US2YT=RR) and three-year (US3YT=RR) notes by $1 billion a month, similar to its increases in the second quarter. Securities maturing in seven years (US7YT=RR) to 30 years (US30YT=RR) should see increases of $1 billion per quarter.
Some analysts also estimate that five-year note (US5YT=RR) sales could ramp up to $1 billion more per month compared with the same amount for the whole of the second quarter.
Short- and intermediate-dated debt are seen as having strong demand and relatively attractive rates. Focusing on those maturities also eases pressure on long-term rates, where large increases in yields could create an economic drag.
The disparity in supply increases could add to yield curve flattening. The gap between short- and long-dated yields is already at decade lows and being closely watched as a potential sign of an economic downturn.
Still, many investors are bearish on Treasuries across the curve. The latest data from U.S. futures exchanges show that hedge funds and speculators last week accumulated a record short position in five-year, 10-year and 30-year Treasuries futures, and also expanded their short position in two-year notes.
In addition, investors will be watching for any new information on when the Treasury plans to introduce new two-month bills and five-year Treasury inflation-protected securities (TIPS)