(The opinions expressed here are those of the author, a columnist for Reuters.)

ORLANDO, Florida - The recent spike in 30-year yields has been the headline story in world bond markets, for good reason. But with so much attention on the long end of the curve, few seem to have noticed the historic developments in the ultra-short U.S. Treasury market.

The weekly sales of four-week T-bills have now reached the landmark threshold of $100 billion, with the September 4 auction marking the fifth consecutive sale at that record-high amount.

This flood of bill sales reflects the government's new strategy. President Donald Trump's administration is seeking to reduce the country's debt maturity profile – and overall interest costs – by borrowing more at the ultra-short end of the curve, while simultaneously pushing the Federal Reserve to lower rates.

So far, it seems to be working.

The Fed appears certain to resume its interest rate-cutting cycle later this month, with investors anticipating at least 150 basis points of easing by the end of next year.

Not only is that bringing down bill rates and short-term bond yields, it's also pulling down longer-term yields. The benchmark 10-year yield is the lowest since April's 'Liberation Day' tariff chaos, while the 30-year yield is again backing away from 5%.

The upshot is that investors lending to Uncle Sam for 10 years, with all the risk that entails, are getting paid an annual 4.08%, while investors lending to the U.S. government for four weeks are getting 4.20%. Unsurprisingly, these bill auctions have elicited strong demand: last week's $100 billion sale was 2.78 times oversubscribed.

So what's the problem?

LET ME ROLL IT

The biggest concern is 'rollover' risk. Concentrating sales at the front end of the curve means the government has to refinance a large chunk of its debt much more frequently. This leaves it vulnerable to unforeseen financial, political or economic shocks that could cause short-term borrowing costs to spike or force the Fed to suddenly raise its policy rate. 

True, Fed expectations are skewed to the downside right now, but what if inflation expectations become unanchored, and the Fed has to pause its easing cycle or even consider raising rates?

That's not an outlandish scenario. The Fed looks set to ease in an environment with 3% inflation, record-high equity markets, the loosest financial conditions in three-and-a-half years, according to Goldman Sachs, and economic growth tracking at 3.5%, based on the Atlanta Fed's latest GDPNow model. And that's not even taking into account the full inflationary impact of Trump's tariffs.

Increased bill issuance has been well absorbed so far, but cash going into bills is depleting liquidity pools and buffers in other parts of the system. The Fed's overnight reverse repo facility is almost empty, and total bank reserves at the Fed are declining.

No one knows what the lowest comfortable level of reserves for the banking system is. It proved to be around $1.5 trillion in late 2019, when a sudden drop below that level triggered significant money market volatility and a spike in overnight rates.

Experts reckon it is higher today, as the economy and banking system have expanded. But reserves are steadily decreasing and look set to fall below $3 trillion. Analysts at Citi warn they will "continue marching" below that level as T-bill issuance grows, potentially putting upward pressure on repo rates and funding costs.

THRESHOLD

With the Treasury leaning more on T-bills for funding, new issuance over the next 18 months could perhaps exceed $1.5 trillion, according to some Wall Street bank estimates.

As a result, the share of bills in the total outstanding federal debt stock is likely to grow too. This portion currently stands at just under 21%, slightly below the historical average of around 22.5% but above the 15-20% range recommended by the Treasury Borrowing Advisory Committee.

Analysts at T Rowe Price reckon the share could soon reach 25%, a level last seen during the pandemic and the Global Financial Crisis, suggesting borrowing policies previously seen in crises could become the new normal.

Of course, none of this will be a problem if increased issuance continues to be met with solid demand.

And there's reason to believe that will be the case. First, money market funds – the biggest buyers of T-bills with holdings representing 36% of the $6.4 trillion market – have seen their assets explode from $4.7 trillion in early 2020 to more than $7 trillion today. And there is now also massive demand from stablecoin issuers looking to back their crypto assets with safe, liquid assets like T-bills.

In short, the market could continue to 'play ball' with the government's new funding strategy. With over $1 trillion of new issuance coming, the Trump administration certainly hopes so.

(The opinions expressed here are those of the author, a columnist for Reuters)

(By Jamie McGeever; Editing by Susan Fenton)