PREVIEW-US Treasury expected to freeze coupon sizes again; spotlight on forward guidance

By Gertrude Chavez-Dreyfuss

NEW YORK, Feb 2 (Reuters) - The U.S. Treasury is widely anticipated to leave note and bond auction sizes unchanged for an eighth straight quarter when it announces financing plans this week, reinforcing its strategy of relying more on bills instead of long-dated debt as it manages a still sizable but narrowing fiscal deficit.

Investors, however, will be looking for clues on what comes next - from the possibility of future coupon increases to whether the Treasury might contemplate cuts in long‑end issuance to help advance the Trump administration's aim of reducing long‑term borrowing costs.

"If they increase the coupon auction sizes, it's probably going to be in 2027 and it's going to focus on twos and threes (two- and three-year notes)," said Guneet Dhingra, head of U.S. rates strategy at BNP Paribas.

"Increasing coupon sizes based on the Treasury statement during the November refunding does not suggest automatically that the increase in coupons is going to be anything beyond the very front end."

The country's top fiscal authority said in its refunding announcement in November that it is beginning to consider future increases in auction sizes for notes and bonds.

The Treasury will release its quarterly borrowing estimates at 3 p.m. EST (2000 GMT) on Monday, followed by the quarterly refunding details at 8:30 a.m. EST (1330 GMT) on Wednesday. The refunding outlines the Treasury's financing plans for the first and second quarters, including auction sizes for three-year and 10-year notes as well as 30-year bonds.

The financing forecasts offer investors a more detailed breakdown of the Treasury's assumptions for April tax receipts - a key factor for near‑term borrowing needs - and the outlook for bill supply. They will also clarify how the Federal Reserve's recent bill purchases factor into the debt issuance plan.

The Treasury said in November it expects to borrow $578 billion in the first quarter of 2026, assuming a cash balance of $850 billion at the end of March.

J.P. Morgan, in a research note last week, said it expects lower financing needs this quarter of just $498 billion, helped by the Fed's recent purchases of short-term bills of $40 billion per month. The Fed's bill-buying program, also called reserve management purchases (RMPs), decreases the need for the Treasury to borrow from the private market, lowering the net bill supply to the market.

Those U.S. central bank purchases will remain elevated until April, after which the pace of bill-buying is expected to slow.

Still, with the nomination of former Fed Governor Kevin Warsh as the next U.S. central bank chief, the T‑bill buying program could be reassessed. Warsh has advocated for reducing the balance sheet.

Another factor reducing U.S. borrowing needs is the smaller‑than‑expected fiscal deficits projected for 2025–2027, driven in part by higher‑than‑forecast tariff revenues, Morgan Stanley analysts said.

A narrower deficit means less pressure on the Treasury to issue more debt, providing more flexibility to keep coupon auction sizes unchanged for longer.

CUTTING AUCTION SIZES?

Some market participants wonder whether the Treasury will employ a more activist approach, reducing long‑end coupon auction sizes in an effort to lower those yields and, ultimately, mortgage rates, although analysts from J.P. Morgan and Morgan Stanley said it was unlikely.

"It would be a significant pivot from last quarter's guidance, which also noted the Treasury has preliminarily begun to consider 'future increases' to coupon auction sizes," J.P. Morgan analysts wrote in a research note.

"A swift 180-degree pivot would not be consistent with a 'regular and predictable' approach to debt management strategy."

Overall, the Treasury will continue to issue more short-term bills to address its financing needs, instead of funding them with long-term bonds.

The move away from the long end has been partly driven by market considerations, analysts said, with the Fed holding its benchmark interest rate at a still-elevated 3.50%-3.75% target range amid inflation and labor market concerns. That Fed policy rate level has raised the opportunity cost of owning longer-dated bonds, prompting investors to demand higher yields at that part of the curve.

By issuing more short-term debt such as T-bills, which have lower yields than the long end, the Treasury can borrow at lower rates, reducing immediate interest expenses. Treasury Secretary Scott Bessent has said increasing long-term bond issuance at current elevated yields is not cost-effective.

"I think the Treasury is particularly sensitive to making any adjustments to long-end issuance anytime soon, and probably will wait as long as possible as they explore these other avenues to finance what's ultimately an elevated deficit," said Zachary Griffiths, head of investment grade and macro strategy at CreditSights.