UPDATE 3-U.S. may reduce borrowing as budget gap shrinks
* Smaller budget gap could delay debt ceiling fight -analysts
* Analysts now see debt ceiling reached closer to October
* Treasury plans to index FRNs to three-month bill auction rate
WASHINGTON, May 1 (Reuters) - The U.S. Treasury Department said on Wednesday it might be able to sell less long-term debt in the future if the U.S. budget deficit continues to come down.
In its quarterly debt refunding announcement, the Treasury did hold the sizes of its longer-dated debt sales steady this quarter. It said on Wednesday that it would trim issuance of short-term bills to take into account a drop in its borrowing needs, which is expected to persist until the end of June.
A bigger-than-expected rise in tax receipts to Washington has improved the U.S. fiscal outlook, and the Treasury and private analysts have been taken by surprise by how quickly the deficit is shrinking. Belt tightening in the wake of the series of mandatory budget cuts worth $85 billion - known as the "sequester" - could further reduce federal borrowing needs if it doesn't inflict lasting damage to the economy.
The Treasury earlier this week said it would pay down debt in the third quarter for the first time in six years. The improved view means the U.S. Treasury could stave off the date when it bumps up against the legal limit on the nation's debt until October using emergency cash measures; analysts a few weeks ago thought the limit could be hit in June.
Higher tax receipts "will give Congress some breathing room on the debt ceiling debate and they will not have to come up with an 11th hour deal before the August recess," said Bill Irving, portfolio manager at Fidelity Investments in Merrimack, New Hampshire.
The government's first-time paying down its debt since the Great Recession should lower its short-term borrowing costs as well as those for banks and Wall Street, analysts said.
The Treasury also agreed to set the interest rate for its planned floating-rate notes against the rate cleared at the weekly three-month bill auction. The final rule on the notes should be issued in the coming months, and the first auction should happen either in the last quarter of this year or the first quarter of 2014.
Deputy Assistant Secretary James Clark said Treasury was considering issuing $10 billion to $15 billion in floating-rate notes each month, according to minutes of the Treasury Borrowing Advisory Committee, published on Wednesday. The committee also agreed the notes should start with a two-year maturity.
Fidelity's Irving said the expected drop in the deficit should lower the U.S.'s overall debt burden, perhaps lowering its deficit-to-gross domestic product (GDP) ratio to about 5 percent this year from 7 percent last year. "With our debt-to-GDP stabilizing, it will help the U.S. maintain its safe-haven status. That's very good for Treasuries," he said.
FILLING GOVERNMENT COFFERS
Tax receipts so far this year have been higher than expected due partly to the expiration of the payroll tax holiday at the start of the year, while tax refunds were lower than in previous years, according to the committee's minutes.
Analysts also attributed higher tax revenues to some workers' move to paying taxes on their compensation at 2012 tax rates rather than risking paying them at higher ones this year.
As a result, the Treasury had $79 billion in cash at the start of April, more than double what it had forecast. This resulted in a sharp cutback on bill supply since mid-April.
Analysts cautioned this pickup in tax receipts might not last as the economy may head for a slowdown. It seemed the Treasury's borrowing committee seemed to share this view too.
"Members concluded that it was more prudent to wait and better understand the increase in receipts before making a decision to adjust financing," the minutes said. Members of the committee decided that adjusting bill issuance could help manage funding needs for now.
Therefore, Treasury said it would stick with similar auction sizes as in previous quarters, with $32 billion in three-year notes, $24 billion in 10-year notes and $16 billion in 30-year bonds. The auctions together will raise about $12.4 billion in new cash, officials said.
Treasury declined to give a precise estimate for when the government will run out of borrowing room after the suspension of the debt limit expires on May 19, but said it will begin emergency measures immediately if Congress does not raise the debt ceiling.
Officials said it was hard to estimate how much time emergency cash measures could provide due to uncertainty about how government spending cuts, the pace of the economic recovery and the timing of other "sizable cash flows" would affect government coffers.
Analysts are now predicting the United States may not hit the legal limit on its debt until October, giving Republican lawmakers more time to use the debt limit as leverage to extract spending cuts.
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