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

Dear Mr. Secretary,

Since the TBAC last met in early August, Treasury markets have repriced toward a higher path for interest rates, reflecting stronger economic activity and associated financing needs, persistent energy-supply disruptions, and the Federal Reserve's initial rate hike and projections for further increases. The selloff in rates was led by the front end of the yield curve, with two-year yields rising by roughly 50bps and ten-year yields by roughly 40bps. The move accelerated in September and early October, with ten-year yields peaking around 5.4% and thirty-year yields around 5.7% in early October. Some of that increase has since reversed.

A substantial part of the repricing reflected stronger U.S. economic activity through the summer despite higher energy prices and rising rates. Household spending remained resilient as gains in financial wealth and lower savings rates cushioned pressure on real incomes. Existing fixed-rate mortgages limited the increase in homeowners' debt-service costs, even as higher rates on new borrowing weighed on housing activity. Meanwhile, strong investment in computing equipment, intellectual property, and data centers offset weakness in more rate-sensitive investment. The infrastructure buildout proved less sensitive to financing costs than traditional housing-led expansions. Related gains in construction and equipment manufacturing are becoming visible but have not yet generated a broad acceleration in employment.

This resilience gave the Federal Reserve greater scope to respond to persistent inflation risks exacerbated by the energy shock. Supply disruptions that began over the summer have proved more persistent than initially expected, keeping crude and refined-product prices elevated through the quarter and feeding into transportation and freight costs. Headline CPI accelerated to 3.7% in September, with gasoline alone accounting for more than half of the monthly increase. Core CPI ran at 2.6% as fuel and freight costs passed through to other categories.

The Federal Reserve responded in September by raising its target range by 25 basis points to 3.75%-4.00%. Chairman Warsh emphasized both the strengthening economy and insufficient progress on inflation, characterizing the decision as removing accommodation rather than making already restrictive financial conditions materially tighter. The September Summary of Economic Projections reinforced the higher-for-longer message: the median policy-rate projection rose to 4.1% for both year-end 2026 and year-end 2027, compared with 3.8% and 3.6%, respectively, in June. Markets continued to price approximately three additional rate increases over the coming year even as the Fed held rates steady in October. More recently, higher borrowing costs and emerging weakness in equity and credit markets have moderated expectations for the pace of tightening but not eliminated expectations for further increases.

Several cross-market and technical developments came into play over the quarter:

• Term premium has risen less than yields this year, though the ten-year term premium showed some strain in the early fall. The Federal Reserve Bank of New York's ACM model estimate of the ten-year term premium rose approximately 20bps in September. Interest rate implied volatility rose sharply, reflecting greater priced uncertainty and raising the cost of option-based protection against further yield increases. As yields rose and refinancing incentives diminished, mortgage durations extended, prompting convexity hedgers to reduce duration. Collateralized mortgage obligation floaters with coupon caps added to hedging pressures as forward-implied coupons approached their caps, likely increasing demand for intermediate-dated rates volatility. These flows likely amplified the initial selloff and increase in volatility, although the scope for further mortgage-duration extension diminished as yields moved higher.
• Stronger economic activity was also driving expectations of higher interest rates outside the United States. The European Central Bank and Bank of Japan raised policy rates over the period as markets priced a broader tightening cycle across major developed economies. Developments in European sovereign markets were also relevant for Treasuries, as fiscal and political uncertainty produced a sharp widening in French government-bond spreads, adding to volatility across global fixed-income markets. Those linkages have not operated uniformly: the correlation between French and U.S. yield changes weakened in October, and more acute French stress subsequently supported safe-haven demand for Treasuries and German Bunds.
• Technology-related financing remained an additional influence on capital markets and financial conditions. Large debt offerings and prospective mega-IPOs reflected substantial private-sector financing needs. Heavy technology issuance and uncertainty over future financing needs contributed to wider spreads in the sector and increased competition for long-duration capital. Banks and asset managers also helped technology companies tap a broader pool of capital through GPU-backed loans, equipment leases, and data center project financing. Foreign investor demand to finance U.S. technology contributed to dollar strength, providing an additional channel of financial tightening alongside higher borrowing costs. Although large issuance windows may influence Treasury concessions and hedging flows at the margin, there is no evidence of a persistent deterioration in Treasury auction demand. Recent auctions remained generally resilient, though individual results varied.
• Technology news also contributed to weaker risk sentiment later in the period, helping restore demand for Treasuries. By late October, the Nasdaq 100 had fallen just over 7% from its early-October high amid greater scrutiny of the returns on increasingly debt-financed technology investment. Together with wider credit spreads, the equity pullback helped restore a safe-haven bid for Treasuries, partially reversing the earlier rise in yields.

Against that backdrop, the Committee convened for its quarterly refunding discussion. The outlook shows the funding gap widens over FY27 and increases further in FY28 and FY29. Consistent with Treasury's cash management policy, Treasury recently published cash balance assumptions for the end of Q1 FY27 and Q2 FY27 at approximately $850 billion and $1 trillion, respectively.

The Committee next addressed the first of its two charges: Super Intelligence (SI)-related issuance. Members discussed recent trends in corporate bond issuance related to SI and associated businesses. Members noted the market is in the midst of a significant technology financing cycle. Financing is also expanding beyond long-dated corporate bonds, with secured and asset-backed structures increasingly bringing issuance inside 10 years. Taken as a whole, the technology ecosystem appears to have both the capacity and incentive to sustain borrowing and investment.

Foreign demand for U.S. fixed-income assets has accelerated this year, while the broader investor base retains significant capacity to absorb additional issuance. Insurers, pensions, households, and foreign investors provide diversified sources of demand, with households and private pensions still relatively under allocated to fixed income. Even modest reallocations from cash and equities could therefore absorb a meaningful share of projected borrowing.

Treasury auction results show no evidence that 2026 technology-related issuance has crowded out long-end Treasury demand. To the extent technology investment is affecting rates, the Committee viewed the transmission as stemming from stronger growth rather than through crowding out. Higher Treasury yields have primarily reflected growth, policy expectations, and energy prices rather than an issuance-driven supply shock. Members emphasized, however, that the financing cycle remains in its early stages and recommended that Treasury continue to monitor potential effects on Treasury market demand as SI-related issuance grows.

The Committee's second charge focused on Treasury derivatives and their growing role in the market. Since the 2022 rise in yields, asset managers have increasingly used futures to gain synthetic Treasury exposure, while liability-driven investors, including pension funds and insurers, have used interest rate swaps to manage duration. The Committee emphasized that expressing duration through derivatives enhances demand for Treasuries by broadening market access and expanding intermediation capacity.

In the context of discussing derivatives, the Committee identified several policy options that could further improve demand for cash Treasuries. These include easing regulatory constraints on balance sheet capacity, including exempting Treasuries from leverage ratios and recognizing pre-positioned discount window collateral in liquidity metrics; expanding access to repo financing; improving the availability of term repo; and enabling new entrants in repo market making. The Committee also recommended evaluation of fund accounting treatment of repo interest, tax treatment, and operational challenges. Together, these steps could broaden and diversify the base of cash Treasury holders, strengthen market intermediation, and support durable demand for Treasuries.

The Committee discussed the efficacy of the liquidity support buyback program. There is a variety of evidence that the program has supported liquidity conditions since it was introduced in 2024, and buybacks remain an effective tool for that purpose. While an effective tool, the Committee believes that any management of Treasury's maturity profile should be done via changes to auction sizes.

To further the goal of financing the government at the lowest cost over time, the Committee continues to endorse an issuance strategy that balances expected costs and volatility of interest expense, matches issuance patterns to market demand, encourages smooth market functioning, and is regular and predictable. As members look ahead, baseline fiscal projections suggest that current auction sizes are likely to shift Treasury's debt profile toward an increasing share of bill and shorter-term funding. The Committee believes that the market has recently been absorbing Treasury issuance well and that the bulk of recent interest rate rises reflect strong economic conditions and the monetary policy outlook rather than weak investor demand for Treasuries. The Committee discussed that real money investors, including retail and some institutional investors, have grown their demand as rates have risen and as a hedge against downward moves in economic conditions. However, the Committee also noted that money market fund assets have leveled off and the bill market has started to show some signs of price sensitivity.

In light of that outlook, for the current quarter, the Committee recommended keeping nominal coupon, FRN, and TIPS auction sizes unchanged. However, the Committee believes that given current fiscal projections, increases in coupon auction sizes will be warranted later in FY27. Looking ahead, given the projected funding gaps in FY28 and FY29, members discussed different approaches to coupon increases over the horizon. While there is broad agreement across the Committee to increase coupon auction sizes, there was considerable debate around the pace and sizing specific to the long end of the curve.

Members recommended that Treasury change its forward-guidance language and emphasized that clear communication alongside a regular and predictable operating framework remains important to help market participants adjust to future changes.

In conclusion, consistent with its past messaging, the Committee encourages Congress to act to raise or suspend the debt limit to avoid disrupting Treasury market functioning, increasing costs to the taxpayer, and constraining economic growth.

Respectfully,

Jason S. Granet

Chair, Treasury Borrowing Advisory Committee

E. Alexander Schiller

Vice Chair, Treasury Borrowing Advisory Committee