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Report to the Secretary of the Treasury from the Treasury Borrowing Advisory Committee.

Letter to the Secretary

Dear Madam Secretary:

Economic activity rose at a faster pace in the fourth quarter of 2021, in part reflecting recovery from the impact of the Delta variant in Q3. Real GDP grew at a 6.9% annualized rate, above consensus expectations, though this reflected a 4.9pp contribution from inventory accumulation.

Since mid-December, the spread of the Omicron variant has reduced spending and disrupted operations in many industries. In particular, the number of workers who were temporarily unavailable to work for virus-related reasons increased sharply. Thousands of flights were cancelled because of staff shortages, office occupancy declined as companies delayed return-to-office plans, and both restaurant and air travel spending declined. These setbacks now appear to be diminishing in the US as virus cases fall. However, many other countries have tightened Covid-related restrictions, and concerns remain about spillover effects to the US economy from disruptions caused by virus-suppression efforts abroad.

Forecasters expect the economy to decelerate in Q1, reflecting the impact of both Omicron and reduced fiscal support, including the end of the expanded child tax credit. While further fiscal negotiations are ongoing, most analysts expect a substantial decline in total fiscal support in 2022 from elevated levels in 2021. Additional reopening of the service sector could further restore normal spending opportunities, especially if advances in treatments and testing further reduce Covid fears.

Payroll employment gains averaged 365k per month in 2021Q4, and the unemployment rate fell to 3.9% in December, a 0.8pp decline since September. The labor force participation rate rose 0.2pp to 61.9%, but remains well below the pre-pandemic trend. Total labor demand, summing the number of workers employed and job openings, remains at the pre-pandemic level. In contrast, the labor force remains 2.3 million workers short of the pre-pandemic level. This has led to a very tight labor market and strong wage growth in recent quarters.

Inflationary pressures have remained strong in recent months. Core goods prices have grown quickly as auto prices have reaccelerated and supply-side problems have persisted, core services prices have grown at a faster pace recently as rent growth has picked up, and #food and #energy #prices have risen quickly too. Short-term #inflation expectations remain very high.

The Federal Reserve announced that it will finish tapering its asset purchases in March. A rate hike at the March meeting is widely expected, and the Federal Open Market Committee (#FOMC) has also begun to discuss shrinking its balance sheet. Chair Powell recently emphasized that the economy is in a different place than it was in the last hiking cycle and that the FOMC must be in a position to adjust policy in a nimble manner. Market expectations for policy rate hikes in 2022 have been brought meaningfully forward, implying over 4 hikes in 2022, and broader financial conditions have begun to tighten.

Since the last refunding, #equity prices have fallen by roughly 4% (down 8% since the peak), and the trade-weighted dollar rose by 3%. Interest rates have continued to rise amidst a meaningful flattening of the #yield curve, with the 2-year Treasury yield up 70bps to 1.16% and the 10-year yield increasing 23bps to 1.78%. The long end has remained quite contained, with the 30-year yield rising only 14bps to 2.10%.

In light of this financial and economic backdrop, the Committee reviewed Treasury’s February 2022 Quarterly Refunding Presentation. Based on the marketable borrowing estimates published on January 31, the Treasury currently projects a net privately-held marketable borrowing1 need of $729 billion for Q2 FY 2022 (Q1 CY 2022), with an end-of-March cash balance of $650 billion. For Q3 FY 2022 (Q2 CY 2022), the net privately-held marketable borrowing need is estimated to be $66 billion, with a cash balance of $700 billion at the end of June. These estimates do not include impacts from any additional legislation that could potentially be passed.

The Committee reviewed one charge that considered the market impact of recent coupon reductions and discussed recent developments that will affect the path of auction sizes going forward. Though Treasury delivered coupon reductions broadly in line with expectations in the previous refunding quarter, the 7- and 20-year maturity points continued to cheapen under several relevant metrics, which members felt reflected insufficient end-user demand relative to the amount of supply. Going forward, Treasury’s funding outlook has evolved in several important ways, most notably the timing of reductions in the Federal Reserve’s SOMA portfolio, which are now expected to begin around mid-year and to be sizable. This shift would increase the amount of debt that the Treasury...