Big News on U.S. Bonds! BofA: Fed’s Portfolio Adjustment Could Bring $2 Trillion to Treasury

On August 16, according to Bank of America’s analysis, if the Federal Reserve adjusts the structure of its Treasury portfolio, it could purchase nearly $2 trillion in short-term Treasury bills (T-bills) over the next two years—almost enough to cover all of the Treasury’s T-bill issuance during that period.

BofA strategists Mark Cabana and Katie Craig noted that the Fed is expected to rebalance its portfolio to better align assets with liabilities, thereby reducing interest rate risk and negative equity while shortening the duration of its liabilities. This adjustment would also unexpectedly provide a significant boost to the Treasury, which has been ramping up short-term debt issuance to cover fiscal deficits and replenish cash balances that plummeted after the debt ceiling was raised last month.

Cabana stated, “If you assume the Fed reinvests all maturing and prepaid mortgage-backed securities (MBS) into T-bills and rolls maturing long-term Treasuries into T-bills as well, it could reach roughly $1 trillion. That almost exactly matches the Treasury’s T-bill issuance, meaning a new source of demand has emerged in the short-end market.”

According to BofA’s estimates, if the Fed shifts nearly 50% of its assets into T-bills, it would better match its short-term liabilities (primarily reserves and reverse repos) while also absorbing fluctuations in the Treasury’s cash balance. They project T-bill supply at $825 billion in fiscal 2026 and $1.067 trillion in fiscal 2027, assuming the Treasury keeps long-term bond auction sizes unchanged until October 2026.

This shift would help ensure robust demand for short-term government debt, alleviating concerns that the Treasury’s massive issuance could drain market liquidity.

Although the Fed is still in the process of quantitative tightening (QT), BofA strategists noted that recent remarks from policymakers suggest they may have already discussed portfolio adjustments at July’s FOMC meeting, with minutes expected on August 20. Governor Christopher Waller has publicly advocated this strategy to achieve the “optimal mix” of assets, while a senior advisor’s recent research paper echoed the same stance.