US Treasury yields at 5% can’t be contained? Wall Street throws out a “reverse subscription window,” Treasury Department may be forced to change tactics.

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The yield on long-term U.S. Treasury bonds has broken through the 5% mark, and Bank of America has proposed an unconventional plan—a "reverse inquiry window"—suggesting that the Treasury issue bonds directly to end investors, bypassing the traditional auction mechanism, in hopes of precisely stimulating demand and curbing further rises in long-term rates.

According to Wind Trading Desk, Bank of America pointed out in its latest report that the supply of U.S. Treasury bonds is huge and expected to continue expanding, while structural demand is steadily weakening due to concerns about fiscal discipline, high inflation, and periodic volatility in the Treasury market. The cheapness of long-term rates relative to SOFR has appeared across the curve, especially for 20-year and 30-year maturities.

The report believes that with limited room for conventional measures, the "reverse inquiry window" may become a new option for the Treasury to suppress long-term rates. If the Treasury advances this mechanism, it will support the widening of asset swap spreads for long-term Treasuries, and the extent of the spread widening will depend on the window mechanism's actual effectiveness. This proposal has not yet been officially endorsed by the Treasury, but as long-term demand continues to be under pressure, market attention to such innovative tools will keep rising.

Structural weakening of long-term demand, conventional tools struggle

The core contradiction facing the U.S. Treasury market now is: supply continues to expand, while structural support on the demand side is collapsing. Concerns over fiscal discipline, persistently high inflation expectations, and periodic intense volatility in the Treasury market are together eroding the willingness of long-term investors to allocate.

From market pricing, the cheapness of Treasuries relative to SOFR is evident across the yield curve, most noticeably at the long end. The yield premium of 30-year U.S. Treasuries over the 30-year federal funds OIS is as high as about 85 basis points, reflecting the market's continued pricing of long-term supply and demand imbalance.

Against this backdrop, the market generally expects the Treasury to keep the issuance amounts of coupon bonds unchanged at all tenors during the May quarterly refunding meeting. This expectation has been fully absorbed; merely "holding the line" can no longer effectively curb long-term rates, so the Treasury needs to seek more innovative tools.

"Reverse inquiry window": a new bond issuance mechanism directly reaching end demand

The "reverse inquiry window" is essentially a demand-driven issuance tool. Unlike traditional auctions, where the Treasury sets the issuance amount and the market clears via price, this mechanism allows end investors to proactively submit subscription demands. The Treasury then issues customized bonds directly, without needing dealer intermediaries.

In specific design, Bank of America outlines a preliminary framework: applicable to tenors of 10 years and above; minimum issuance per transaction is about $100 million; the Treasury can issue new CUSIP bonds with any coupon (including zero-coupon) and maturity date, pricing referenced from the spline curve used in repo operations or market bid/ask quotes, plus about 5 basis points service fee. Participation is open to direct auction investors and dealer-submitted inquiries.

This window mechanism supplements, rather than replaces, the existing "regular & predictable" (R&P) issuance framework. The Treasury can keep auction sizes unchanged at the long end while using the window mechanism to meet incremental demand. If window demand is strong, the Treasury can consider gradually trimming long-end auction size; if demand is weak, the project can be closed at low cost. The report cites previous instances: buyback operations were initially criticized for violating R&P principles, but now have become routine tools.

Potential impact on market and dealers

Any move to promote the reverse inquiry window will support the widening of long-term Treasury asset swap spreads. The logic is: the window mechanism can more precisely match long-end supply with genuine demand, reducing liquidity premiums arising from oversupply.

For dealers, the impact may be limited. The long-end window mechanism may reduce dealers' bond stripping activities, but this helps alleviate backlog in their Treasury market-making books. The report clearly states that dealers' core role as New York Fed counterparties will not change.

Bonds issued via the window will have significantly lower liquidity than standard auction bonds. Bank of America expects initial demand mainly from long-term holding investors. Such bonds are not expected to be included in Treasury indexes, as their holders are dispersed and their size is small compared to outstanding debt.

Historical precedent and global reference: a unique American path

This idea is not without precedent. The report traces back to August 2013, when after the "taper tantrum" shock, the Treasury Borrowing Advisory Committee (TBAC) discussed "reverse inquiry and window-driven issuance" in its quarterly report. At that time, the Treasury solicited TBAC opinions on how to "minimize borrowing costs, optimize liability structure, enhance market liquidity, and expand investor base." Ultimately, the Treasury decided that adhering to the R&P principle yielded more benefit than the cost of introducing alternative tools and did not advance the proposal.

Globally, major sovereign debt management offices (DMOs) in advanced markets have not adopted the reverse inquiry window mechanism; Germany, UK, France, Netherlands, Canada and other major economies use auctions as their main method, occasionally supplemented by syndications.

By comparison, U.S. Government-Sponsored Enterprises (GSEs) and supranational, sovereign and agency issuers (SSAs)—including Fannie Mae and Freddie Mac—have widely used such window mechanisms. The U.S. Treasury has the conditional opportunity to become a pioneer in sovereign debt management among developed markets.

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The above content is from Wind Trading Desk.

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