Treasury auction sizes will increase on average 23% in 2024 across the yield curve, see chart below. This forecast comes from the Treasury Borrowing Advisory Committee’s neutral issuance scenario.

The 37% increase in issuance of 3-year notes and the 28% increase in issuance of 5-year notes will in 2024 stress-test demand for Treasuries in the belly of the curve. In particular, if the Fed next year will start cutting rates and wants to soften financial conditions.

This dramatic growth in the supply of the risk-free asset is “pulling dollars away” from other fixed-income assets, including investment grade credit, as investors substitute away from spread products toward Treasuries.

With the ongoing significant increase in the supply of Treasuries, investors in credit markets need to spend some time on signs of demand and supply imbalances in the Treasury market.

The bottom line is that the world only saves a limited amount of dollars every year, and the significant growth in the size of the Treasury market is at risk in 2024 of crowding out demand for other types of fixed income.

The Fed is in the process of cooling the economy down. The whole idea with raising interest rates is for us to buy fewer cars, spend less on our credit cards, and to build fewer factories.

The Fed’s ultimate goal is to get inflation back to their 2% inflation target. But with core PCE inflation currently at 3.9%, we are not there yet.

The desired slowing of the economy could come this Friday when we get the employment report for September.

The consensus expects 165,000 jobs in September, which is down from 400,000 jobs a year ago and 600,000 when the Fed started raising rates in March 2022.

What will happen in credit markets over the coming months once nonfarm payrolls finally move below the level consistent with population growth, namely, 100,000 jobs created each month?

Once nonfarm payrolls start moving below 100,000, credit spreads will widen because investors will take it as a sign that corporate earnings are about to slow down, see illustration below.

But with core PCE inflation at 3.9%, the Fed cannot turn dovish because it will look like the Fed no longer cares about inflation, which raises the risk of inflation expectations becoming unanchored. As a result, the Fed will continue to be hawkish even as the unemployment rate starts moving higher.

Once the recession finally begins, the Fed can turn dovish and start to lower base rates. But the costs of capital will not decline because at that time corporate earnings will be slowing, and therefore, credit spreads will likely be widening further.

The bottom line is that even if we get weak data and the Fed, after a few soft prints in nonfarm payrolls, starts turning dovish, the costs of capital will move higher. In short, the Fed controls the base rate but doesn’t control credit spreads, and that is the reason why a soft landing is unlikely.

Maybe China is behind the rise in US long rates. Growth in China is slowing for cyclical and structural reasons, and Chinese exports to the US are lower. As a result, China has fewer dollars to recycle into Treasuries. In fact, China has been selling $300 billion in Treasuries since 2021, and the pace of Chinese selling has been faster in recent months, see charts below and the presentation available here.

If slowing growth in China is a source of higher US rates—together with the US sovereign downgrade, Fed QT, Japan YCC exit, and rising US Treasury issuance—then a bad US employment report on Friday may not result in dramatically lower rates.

The bottom line is that the cost of capital will likely stay permanently higher for reasons that have little to do with the business cycle, and it was the period with essentially zero interest rates from 2008 to 2020 that was unusual.

Bad weather has pushed the price of orange juice to the highest level ever, see chart below.

Our updated banking sector chart book is available here.