US Rates - I won’t see you next time

You're listening to At Any Rate, J.P. Morgan's global research podcast, where we take a look at the story behind some of the biggest trends and themes in fixed income, currency and commodity markets today. I'm your host, Teresa Ho, head of U.S. short-duration strategy.

We're now almost two months into the Middle East conflict. Brent crude is currently trading at around $107 per barrel, coming off from a high of $126 per barrel earlier this week. Treasury yields are also broadly higher across the curve, with the curve slightly flatter, with two-year and 10-year yields up about 10 basis points and six basis points, respectively, week over week.

We also got a slew of data, which generally pointed to an economy that is still doing okay, with inflation maybe nudging a little bit higher. And against this backdrop, we have month end, which in the funding markets came and went with no hiccups, which was a good thing. We also have the Treasury's May refunding next week.

So needless to say, there was a lot that happened this week and more to come next week, from the Fed to the oil, to oil to Treasury refunding, lots to unpack here. And to help me unpack what's going on in the markets, I'm joined by two colleagues today, Ipek Ozo, head of interest rate derivative strategy, and Amanda Burke, U.S. rate strategist. Ipek and Amanda, thanks for being here.

Great to be here. Thanks for having us. Ipek, I'd like to turn to you first and talk about the Fed and what that means for the rates markets.

Wednesday's decision was a hold, but it came with a lot of signal. The vote was split. Governor Meehan dissented for a cut, while Presidents Hammock, Kashkari, and Logan, they dissented the other way, in favor of removing the easing bias entirely.

So you have one dove, three hawks in the committee holding overall. And perhaps most importantly, Powell also said he intends to stay on as Fed governor as Kevin Warr steps in as Fed chair. That's an unusual transition dynamic that can influence how markets think about the Fed's reaction function.

I guess this backdrop, how are you thinking about this? I mean, the rates market repriced in the front end and the curve flattened. What does this mean for you going forward?

So I mean, that's right, Theresa. So as you said, three members voted to keep rates on hold, but dissented on the language, preferring to remove the easing bias in the statement. And actually their statements today also reflect concerns around inflation and why they dissented this way.

So what we can take away from that is that there is a growing cohort of voting members who see hikes as equally likely as cuts as the next move. And if you look at the implied distribution from options on SOFR futures, you actually see a pretty similar lean in the markets. And the shift has been quite drastic.

So before the start of the conflict, there was roughly, call it 50% weight on two or more cuts this year. And now the distribution has shifted significantly to the right with almost equal probability on various scenarios, including cuts as well as hikes. So that's a meaningful shift.

And I think the dissents from the committee members kind of point to a similar shift in the committee. And, you know, also in the press conference, Chair Powell stressed that Fed policy decisions are made by collective judgment of the board, stressing the importance of the chair in building consensus among the participants. And you know, with more FOMC members reluctant to lower rates anytime soon, Warsh, incoming chair, may meet opposition from the FOMC on many of the views that he mentioned in his testimony last week.

So that being said, talking about the Fed, we still have the Fed on hold for the remainder of the year, and we see the next move next year as a hike. And in terms of our rates views, we think there could be more room for them to go higher despite the, you know, 10 basis point increase this week. And of course, you know, we do recognize that there is a risk to this that could come from continued oil price increases, which can actually reverse things and impact growth and trigger recession risks.

And our economists put that probability on like 35%. But I think big picture, FOMC meeting basically opened the door to the right side of a distribution and it could result in edits to the easing statement in the next meeting. And overall, we do see yields as biased slightly higher from here.

Got it. That's really helpful. And what about vol?

I mean, volatility itself has been quite volatile lately, and that seems to have been increasing again. Yeah, so vol of vol, as we call it, has been pretty high, exactly as you said. And it's been mostly driven by the Middle East conflict.

So if, and the direction has been if it seems like the conflict is about to ease, vols come down and vice versa. And vols increased over the past two weeks as well. And they also increased following the FOMC meeting, because again, the distribution of outcomes opened up quite a bit following the dissents and Chair Powell's statements.

And it's hard to know which way vols will go as they remain pretty sensitive to the geopolitical backdrop. But you know, the fact that the distribution of outcomes is wider and the fact that policy uncertainty remains elevated could result in markets to be more volatile over the near term. So Teresa, turning it back to you, I guess the one thing we didn't touch on is the reserve management purchase of the RMPs.

The Fed didn't make any changes to the implementation of monetary policy and kept RMPs at $25 billion. That's right. You know, the Fed didn't make any changes to RMPs, and we didn't expect them to either.

I mean, they had just stepped down the pace of RMPs from $40 billion earlier this year to $25 billion at the March FOMC meeting. So we wouldn't really expect them to step it down again until later this year after they've had some time to assess how the lower pace of RMPs are affecting the funding markets. And for the time being, you know, they've continued to have a very positive effect in the funding markets with funding conditions very orderly.

And SOFR and TGCR are trading below IORB. I think the test will come when we have seasonal bill supply come up this summer and how funding markets will respond to that additional bill supply. Because part of the reason why funding conditions are so soft is, one, we have the RMPs injecting liquidity into the markets, but also, two, there's been a pretty meaningful reduction in T-bill supplies.

So when that supply turns, we'll have to see how the funding markets respond to that. Which actually is a really good segue to the next thing I want to talk about, which is the upcoming May quarterly refunding announcement from Treasury. This is taking place next week.

So Amanda, let's bring you in. The key date is May 6th for the full announcement. Can you tell us what's happened since the last quarterly refunding announcement in February?

And what does that mean for Treasury financing needs and the supply outlook? Sure, Teresa. Thank you.

So maybe taking a step back, since that last quarterly refunding announcement, the Supreme Court has overturned the use of IEPA for broad tariffs, and the U.S. Customs and Border Protection Office were ordered by lower courts to create a system to refund eligible importers for the $166 billion of IEPA tariffs that were already paid. So on that front, we expect roughly $30 billion of refunds to be paid in fiscal year 2026, and $90 billion in fiscal year 2027, with the first wave paid over June and July.

And then on the revenue side, the administration has employed a mix of tariffs under alternative authorities to replace IEPA, but we don't expect those will fully replicate the tariff revenue under IEPA in this fiscal year. So netting all of that, we expect a fiscal deficit of something like $1.98 trillion in fiscal year 2026, which is $105 billion larger than where we were three months ago. So the outbreak of the Middle East conflict has pretty naturally led to questions as to whether this could require increased deficit spending, especially given the headlines we've seen about the White House's $1.5 trillion defense spending budget request.

But on that point, we'd highlight that the White House's budgetary request is not binding and should really be viewed more as an aspirational target that highlights an administration's priorities for the upcoming budgetary process, because ultimately it's Congress that decides on fiscal appropriations in a given year. And with the midterm elections this close, we think time is drawing short for legislative action before House members turn their focus more exclusively to electioneering. That's especially true with prediction markets favoring Democrats to retake one or both of the House and Senate.

So we view the likelihood of these more extreme budgetary spending plans being put up for debate as pretty low. Now having given you all of that setup, we expect $2.252 trillion in net privately held borrowing over this calendar year and $2.282 trillion in the next calendar year. And against that backdrop, on Wednesday, we think Treasury should keep nominal coupon auction sizes unchanged because the current auction calendar leaves Treasury well-financed through fiscal year 2027.

Beyond that point, though, a pretty sizable funding gap emerges in fiscal year 2027 since maturities are set to pick up. And on top of that, both Treasury and TBAC have acknowledged that the next step will be increases sometime in fiscal year 2027. So we see a significant risk that Treasury will remove the at least, and I'm putting that in quotes, from its longstanding forward guidance that it anticipates maintaining nominal coupon and FRN auction sizes for at least the next several quarters.

Got it. That's very comprehensive and very helpful. Now, what about the front end?

I think there's also tariff-related cash flow issue that can matter for bills, right? Can you frame that for us? Yeah, sure.

Well, we expect about $761 billion of the total net privately held borrowing needs to come in T-bills this year. And after netting out Fed purchases, that leaves a $271 billion change in privately held bills. I did mention the refund payments that we expect to come this fiscal year and next.

To the extent Treasury anticipates this increased financing needs into the summer, we would expect T-bill issuance to ramp somewhat higher in advance to avoid the TGA dipping below the five-day minimum as refunds are paid out. Typically, we would expect a downdraft in T-bill auction sizes in June because that's when Treasury prepares for an influx of receipts around the corporate tax day. But the tariff refunds raise the likelihood of seeing a small step up in issuance in June or July and an elevated TGA over the near term.

And how does that tie into the medium-term path for coupons? Well, further out the curve, given those dynamics I mentioned earlier, with maturity set to pick up and leaving larger financing gaps next year, we expect Treasury to begin a multi-quarter series of coupon increases in February of 2027. When it comes to where those increases will happen, we expect them to be focused in the front end and intermediate sectors.

This is for a few reasons. One, the demand for a longer-duration risk-free assets is slowing, and two, TBAC's optimal debt model points towards focusing issuance in the belly as well. Thank you.

And then maybe just one last question. What about the charge questions and the buybacks? Well, we think it's pretty likely that Treasury and TBAC will dive deeper on some of the regulatory questions they asked in this quarter's dealer questionnaire.

In that case, they'd probably discuss the impact of changes in bank regulation on investor demand and liquidity in the Treasury market. Now, both of you are definitely the experts on this, but as a reminder to everyone listening, while the recently proposed regulatory changes to Basel III endgame and the G-SIB surcharge are likely to have a modestly positive effect on funding and repo, we expect the impact is likely to be more marginal than meaningful, and we don't expect those changes to have an impact on Treasury demand or swap spreads. As for buybacks, we don't expect any changes to the program at this meeting.

Really, the program has been working as intended, and if we look at the stylized buyback score framework TBAC introduced last year, we can see liquidity has improved across most centers since February. If market liquidity deteriorates more than we expect, it's possible that Treasury could make modest tweaks to liquidity management operations over time. And actually, on that front, Treasury has discussed broadening buyback participation beyond dealers, which we could hear more about next week.

That's perfect, Amanda. Now, I think we talked a lot this session. Let's close it out there.

I think the big picture is a hawkish hold with a split vote that materially shifted front-end pricing, volatility is moving higher, and May refunding were the fine print on guidance and cash flow assumptions matters at least as much as the headline auction sizes. Ipec and Amanda, thanks for joining, and thanks to our listeners. Stay tuned for more episodes of At Any Rate, J.P.

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This episode was recorded on May 1st, 2026.