The Big Idea
The landscape for debt security supply and demand
Steven Abrahams | December 13, 2024
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.
Growth in outstanding US debt securities, now more than 40% of the global total, came back to life in the third quarter with Treasury debt and corporate and structured credit leading the way. The surging supply found a ready home in foreign portfolios along with a domestic bid from money market funds, mutual funds, life insurers and banks. Trends in both supply and demand have clear momentum going into next year.
The shape of debt securities supply
The outstanding par value of US debt securities rose by $1.23 trillion or 2.05% in the third quarter of this year, according to the latest Financial Accounts of the United States. That brings the total to $61.5 trillion. Estimates from the Bank for International Settlements showed US debt securities at the end of the second quarter with a 40% share of the global total, and that share has likely grown since then (Exhibit 1).
Exhibit 1: US debt securities today likely exceed 40% of the global total
Note: Data includes domestic and international securities and shows all countries with a rounded 1% or greater share.
Source: Bank for International Settlements as of 2Q2024, Santander US Capital Markets
Growth in the last four quarters came almost entirely from Treasury debt and corporate, structured and foreign credit. Treasury debt grew by $683 billion or 2.54%, only slightly faster than recent trailing quarters. Corporate, structured and foreign credit grew by $466 billion or 2.93%, well above the pace of recent trailing quarters. Agency and GSE-backed securities—mostly MBS—and muni securities grew by relatively small amounts, and balances in commercial paper dropped for the second quarter in a row. Growing Treasury securities reflects the rising US federal deficit, and growing corporate securities reflects generally falling rates through the quarter and heavy issuance in almost all credit sectors.
Exhibit 2: Treasury debt and credit led growth in the third quarter
Source: Federal Reserve, Z.1, Table L.208, Dec 12, 2024, Santander US Capital Markets
The latest numbers show Treasury debt dominating outstanding securities with nearly a 45% share, credit next at nearly 27% and agency securities at nearly 20% with muni securities and commercial paper far behind (Exhibit 3).
Exhibit 3: Treasury debt dominates outstanding US debt securities
Source: Federal Reserve, Z.1, Table L.208, Dec 12, 2024, Santander US Capital Markets
The relative pace of growth across sectors matters for spreads, at least assuming stable investor preferences. Treasury debt has grown year-over-year at the fastest pace, up 7.6%, with credit up 7.1%. Agency debt is up only 1.7%. Faster growth in Treasury securities should mean tighter spreads in risk assets over time.
The shape of debt securities demand
Foreign portfolios dominated demand for US debt securities in the third quarter followed by money market funds, mutual funds, life insurers and banks. While the Fed reports outstanding securities by par value, it reports holdings by market value, which is influenced both by changes in holdings and changes in value. The value of foreign portfolios rose by $826 billion or 5.9% with money market funds at distant second, up $276 billion or 7.6% (Exhibit 4). Mutual fund holdings rallied by $263 billion or 5.0%, life insurers by $236 billion or 5.8% and US banks by $211 billion or 3.9%. Other notable gains came in state and local government portfolios, ETFs and property and casualty insurers. Even the Fed portfolio showed an increase despite continuing QT, likely the result of falling interest rates and higher valuation in its remaining securities.
Exhibit 4: Foreign portfolios dominated absolute demand in the third quarter
Source: Federal Reserve, Z.1, Table L.208, Dec 12, 2024, Santander US Capital Markets
Outside of foreign demand, which comes from diverse sources, the gains in other portfolios track clear trends through the year. High rates have drawn record inflows to money market funds, which now hold nearly $6.8 trillion. Generally good returns have helped fixed income mutual funds and ETFs draw strong inflows all year long. Life insurers have seen especially strong growth in annuity lines of business. And banks have started growing securities portfolios this year after shrinking for most of 2023.
Trend watching
Rapid growth is likely to continue in outstanding Treasury debt and credit for the foreseeable future. The incoming administration in Washington has given high priority to extending provisions of the Tax Cuts and Jobs Act of 2017 set to expire in 2025, a policy that the Congressional Budget Office estimates could add 17% to US deficits and that the Brookings Institutional estimates could add 22%. Those could get reduced by efforts to cut federal spending, but that historically has proven difficult. Corporate and structured credit outstanding is also likely to grow, although probably not at the rapid pace of the third quarter.
As for demand, money market funds should keep getting inflows as long as money market rates exceed yields on short Treasury debt and bank deposits, both the competing alternative destinations for cash. Mutual funds and ETFs also look set to keep getting inflows after year-to-date returns of 2.36% in the Bloomberg US Aggregate Bond Market Index. Annuity sales should keep insurer demand healthy, and bank demand will depend on capital requirements and competing opportunities to lend.
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The view in rates
With the Fed likely to cut 25 bp on December 18, the debate turns to what comes next. The market expects only two more additional cuts in 2025, but that looks too light by half. Our US economist expects four cuts, which should take fed funds toward 3.25%. That should bring down 2-year rates into that neighborhood, and 10-year rates should drop below 4.00%.
The Fed will come out with a new dot plot on December 18, and many expect the long-term dot to rise. But it still will likely be in the 3% neighborhood. That suggests the current implied pricing of forward rates—the 1-year forward 2-year rate now at 4.20%—-is too high. In addition, heavy Treasury supply next year should at least slow any decline in intermediate and long rates. The curve should consequently steepen more than implied by forward rates.
Other key market levels:
- Fed RRP balances stand at $136 billion as of Friday. The RRP overnight rate at 4.55% still beats yields on Treasury bills, but not the yield on repo.
- Setting on 3-month term SOFR closed Friday at 435 bp, down 8 bp on the week.
- Further out the curve, the 2-year note traded Friday at 4.24%, up 14 bp on the week. The 10-year note traded at 4.39%, up 24 bp on the week.
- The Treasury yield curve traded Friday with 2s10s at 15 bp, steeper by 10 bp on the week. The 5s30s traded Friday at 35 bp, steeper by 5 bp over the same period
- Breakeven 10-year inflation traded Friday at 235 bp, up by 10 bp in the last week. The 10-year real rate finished the week at 205 bp, up 15 bp on the week.
The view in spreads
Implied rate volatility continues to drop after the elections and the November FOMC, and with Treasury supply putting upward pressure on riskless yields, spreads in corporate debt and MBS should generally keep tightening. Continuing drops in volatility will likely depend on the tariff and immigration policies implemented by the incoming administration.
The Bloomberg US investment grade corporate bond index OAS traded this week Friday at 75 bp, tighter by 3 bp in the last week. Nominal par 30-year MBS spreads to the blend of 5- and 10-year Treasury yields traded Friday at 136 bp, wider by 6 bp in a week. Par 30-year MBS TOAS closed Friday at 42 bp, wider by 8 bp in the last week.
The view in credit
Fundamentals for consumer and corporate credit continue to look stable. The prospect of lower interest rates should slowly relieve pressure on the most leveraged corporate balance sheets and office properties, although a slow Fed pace could delay relief. Most investment grade corporate and most consumer balance sheets have fixed-rate funding so falling rates have limited immediate effect. The rate of serious delinquency in residential mortgages and of loans in foreclosure have barely changed over the last year. And although leveraged and middle market balance sheets are vulnerable, leveraged loan defaults and distressed exchanges have plateaued in recent months.