Treasury refunding preview: T-Bill, t-storm

Summary

There is more clarity on the federal budget deficit outlook than there has been in some time. We project a federal budget deficit of $1.75 trillion in FY 2025, $2.00 trillion in FY 2026 and $2.10 trillion in FY 2027. A substantial increase in tariff revenues should help offset the near-term deficit widening from the One Big Beautiful Bill. A sharp, negative market reaction due to a "fiscal blowout" type scenario strikes us as increasingly unlikely in the near term.

Our base case is that quantitative tightening (QT) will run through year-end, at which point the Fed will keep the aggregate size of its balance sheet unchanged through mid-2026. Under this scenario, we project that bank reserves would hit $2.87 trillion at year-end 2025 and would bottom out around $2.78 trillion in mid-2026. We think the risks are skewed toward QT running a bit longer than this.

At the previous refunding, we made the case that gross coupon auction sizes would remain unchanged until the February 2026 refunding, at which point we expected a cycle of coupon auction sizes to occur. Recent comments from Treasury Secretary Bessent have led us to rethink this view.

We now expect current coupon auction sizes to remain unchanged through year-end 2026. Given this, we think Treasury will leave unchanged its guidance that "Treasury anticipates maintaining nominal coupon and floating rate note auction sizes for at least the next several quarters."

Bill supply will continue to ramp up in the near term. Treasury already has announced a meaningful increase in bill auction sizes, and we project that net T-bill issuance will be $475 billion in Q3, $142 billion in Q4 and $416 billion in Q1-2026. Over the medium term, we project that T-bills as a share of the Treasury market will climb to 22.5% by year-end 2027, up from 21.9% at the end of 2024.

Our new base case is that coupon auction size increases will come in February 2027. A combination of widening budget deficits and a rising maturity wall will put more and more of the issuance onus on T-bills in the absence of coupon auction size increases. We estimate that, in the absence of any coupon auction size increases, net T-bill issuance in 2027 would need to be $1 trillion to meet the projected borrowing need.

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