Treasury’s smaller-than-expected buybacks fuel debate over aims

The US Treasury is acquiring fewer bonds than anticipated through its buybacks of longer-term debt, despite recently broadening the program, sparking investor debate over its objectives and effectiveness. The program allows bondholders to propose specific securities to the Treasury at the prices they are willing to sell. The Treasury can purchase up to its cap, which was recently increased to $6 billion from $2 billion, but it can also decline offers it deems too expensive.

In recent operations, the Treasury has accepted about half of the bonds offered and has fallen short of its stated repurchase cap each time. While some portfolio managers and analysts question why the government publicly expanded the program if it wouldn't buy as many bonds as possible, others say it is adhering to its stated intentions.

Treasury Secretary Scott Bessent argues the purchases are a technical measure to facilitate investors trading older, less liquid government bonds. If the program's primary goal is to support liquidity, or the ability to buy and sell without affecting the market, it appears to be functioning. Yields have risen in recent weeks, but trading hasn't been particularly difficult.

The smaller acceptance rate may also reflect the program's progress in eliminating older, less actively traded bonds from the market, with remaining holders having little incentive to sell or being hesitant to part with the securities. The Treasury plans to buy up to another $6 billion in 10-to-20-year debt on Thursday. Over time, the least liquid securities on the curve are expected to disappear from the market, reducing the need for extensive liquidity support.

Many of the targeted bonds are low-coupon securities issued during the COVID era when interest rates were extremely low. With yields now higher, these bonds have fallen below face value and are difficult to trade in size but potentially cheap to repurchase. This presents a possible debt-management rationale alongside the liquidity rationale.

However, the Treasury must still finance the buybacks, possibly by issuing short-term bills at interest rates far above the coupons on the securities being retired. The broader confusion over the program stems from its August 19 expansion, when the Treasury announced it would at least double buyback sizes for 10-to-30-year debt.

The announcement came two weeks after a quarterly refunding, where investors typically expect updates on borrowing and debt-management plans. The unusual timing, combined with a recent sell-off pushing yields higher, led investors to interpret the move as an effort to cap yields. This out-of-cycle communication, delivered with timing not typical for the Treasury, contributed to the confusion.

Long-end Treasury yields have continued to climb since the buyback announcement, but Treasury analyst Padhraic Garvey attributes this to investors pricing in a Federal Reserve that will keep rates higher for longer, rather than a failed operation. A better gauge, according to Garvey, is the swap spread, which measures how expensive Treasuries are compared to the private lending benchmark SOFR. This spread has narrowed, indicating that the program is working as intended.