Wall Street Loves Washington’s New Debt Approach—For Now

livemint.com:

Swelling deficits and weak investor appetite for long-term U.S. debt are pushing the Treasury Department to get more creative with how it borrows. Markets are thrilled—but the approach comes with risks.

The Treasury has long embraced the mantra of “regular and predictable" debt sales to avoid creating market volatility as it finances the U.S. deficit. Recently, though, high interest rates have driven investors to eschew longer-term Treasurys.

The government has had to adapt, cutting back this month on expected increases in long-term bonds and favoring more short-term debt. The change, while relatively modest, is a sign that the Treasury is trying to manage the market reaction to U.S. debt as the deficit grows.

That has pleasantly surprised investors, sparking a rally in Treasurys that extended this week following a cooler-than-expected inflation reading. “Our quarterly refunding, I think, did show some flexibility with respect to issuance," Treasury Secretary Janet Yellen said recently. “That seems to have had a favorable impact." Yellen said the department still views predictability as the core foundation of its borrowing strategy.

Some on Wall Street warn that any perceived departure from that tenet could backfire. If investors become less certain about the future supply of different Treasury securities, they could demand higher interest rates as compensation. Relying more on short-term bills, which mature in one year or less, similarly could make the government’s borrowing costs more volatile.

There might be times when showing sensitivity to the market could benefit the Treasury in the short term, said Blake Gwinn, head of U.S. interest-rates strategy at RBC Capital Markets. “But if you keep doing that over and over