Dear Mr. Secretary:
Since the Committee’s last meeting on October 29th, the economic situation remains largely the same, if not slightly worse despite the FOMC’s 50 basis point rate cut on November 6th. Payroll growth not only remains below what is generally considered necessary to absorb new entrants into the labor market but fell a total of 189,000 in November and December. The unemployment rate has reached 6.0%. Consumer confidence indicators have all continued to move sharply lower and both inventory and equipment investment have slowed.
However, not all sectors of the economy are weak. The housing market has remained exceptionally strong throughout the downturn as low mortgage rates encouraged home purchases. Additionally, there have recently been signs of improvements in both the business fixed-investment portion of the GDP report and the recent ISM reports. These improvements suggest that a full-fledged recovery may be near for these sectors.
Nevertheless, the balance has tilted toward weakness as the evolving situation in regard to Iraq has permeated throughout the economy. The resulting geopolitical uncertainty is hampering both consumer and business spending. Most economists agree that the risk of sub-par growth remains high despite low and real nominal interest rates.
Since our last meeting, interest rates have stalled with the 2-year yield just 2 basis points lower than at the time of our last meeting despite having traded in a 52 basis point range.
The 10-year yield is just 8 basis points higher and has traded in a 46 basis point range. With continued weakness in the economy and equity markets, combined with the ongoing geopolitical uncertainty, there has been little reason for Treasuries to make a sustained move in any direction.
Most major equity indices are down another 2-3% while volatility has eased. Indeed, while the VIX index, a measure of volatility, is near the same level as our last meeting, it has averaged under 32 during the inter-meeting period versus a 40 reading in the last inter-meeting period.
Budget deficit estimates for FY 2003 continue to evolve as economists attempt to factor in the costs of a potential conflict as well as the impact of the recently proposed tax cuts. At present, most budget deficit estimates for FY2003 now run between $275 billion and $325
billion, in some cases $100 billion higher than at the time of our last meeting. Most expect that the budget situation will deteriorate further in FY2004 and that the budget will remain in deficit for several years to come.
With this economic and financial back drop in mind, the Committee began consideration of debt management questions posed in the Treasury Borrowing Committee Quarterly Meeting Committee Charge.
The first question addressed potential announcement options available to Treasury based on the premise that they planned to re-introduce 3-year note issuance in May, 2003 and to increase the use of long-term financing, primarily in the 5-year note sector, while reducing reliance on bills and 2-year notes.
In response to Treasury’s request for a prioritization of the following announcement options:
1. Intra-quarter re-openings for 5-year notes (starting with the May note), and/or
2. Intra-quarter re-openings of 10-year notes, and/or
3. Further study of one or both of these options.
4. Other options.
the Committee first discussed the optimal minimum size for 3-year note auctions. While the range of suggestions was $15-25 billion, most members agreed that $20 billion 3-year auctions would attract adequate liquidity to the sector while still allowing financing markets to operate efficiently.
Then the Committee turned the discussion to prioritizing what it felt were the three logical choices for Treasury: Intra-quarter re-openings of 5-year notes; monthly 5-year note issuance; and intra-quarter re-openings of 10-year notes. Some members felt that monthly 5-year issuance was almost inevitable over time, and to be as transparent as possible Treasury should bypass re-openings and go directly to monthly 5-year note issuance. The majority, however, felt that quarterly 5-year note re-openings would provide Treasury more flexibility over time to increase and decrease issuance in the sector. Additionally, the doubling of annual auctions would smooth issuance so Treasury was not as dependent on the quarterly auction windows for issuing all of their longer-dated securities. In terms of sizes and timing of 5-year note issuance, the Committee recommended $20 billion auctions with $15 billion re-openings as minimums with the re-opening occurring in the middle of the month following the initial auction. For instance, a 6/16/03 re-opening of $15 billion 5-year notes would follow a 5/15/03 auction of $20 billion new 5-year notes.
The Committee then discussed the merits of monthly 5-year note issuance versus quarterly 10-year note issuance with re-openings if Treasury’s borrowing needs increased beyond what could be handled by quarterly 5-year notes, and re-openings alone. Some members felt that the optical symmetry created by monthly 5-year note issuance would create robust demand while others thought that since historically the market already had experience with monthly 5-year notes and not with intra-quarterly re-opened 10-year notes, the former would prove less disruptive for markets generally. Proponents of intra-quarter re-openings of 10-year notes felt that this option not only created less sense of permanence but also helped Treasury further smooth issuance over the full year, and away from traditional refunding dates. Although relatively evenly split, the Committee decided by a vote of 10-8 to recommend that Treasury consider monthly 5-year note issuance before considering intra-quarter re-openings of 10-year notes.
The Committee then listed other options of debt management available to Treasury for further study and discussion. Relevant topics included by maturity:
1. 9-month or 12-month bills
2. 7-year notes
3. 30-year bonds
4. Additional TIIS issuance
5. New products—floating rate notes, putable notes and a formalized TAP program for outstanding securities.
The Treasury has a stated objective to achieve the lowest cost financing over time. Their objective is to be able to measure their performance around debt management. With this in
mind, Treasury presented a series of slides to the Committee that detailed rough ideas they have on this topic. They were interested in the Committee’s views on how to create a method for measuring their performance. After some discussion, one member of the Committee suggested developing a stated framework of measurement. That is to say, establish a range for duration of the debt, a baseline for budgetary forecasts, and extrapolate forward a potential path of issuance. This would establish a matrix to develop a performance discussion from. This discussion regarding performance measurement was meant to be ongoing, and to expand upon Treasury’s own internal deliberations.
The Committee then turned to the question involving the composition of five- and ten-year notes needed to refund $21.6 billion of privately held notes and bonds maturing February 15th, 2003the composition of Treasury marketable financing for the remainder of the January-March quarter, including cash management bills if necessary, and the composition of the marketable financing for the April-June quarter.
For the January to March quarter the Committee recommended a new $24 billion 5-year note due February 15, 2008 and a new $20 billion 10-year note due February 2013, representing a $2 billion increase for each security from the prior quarter. For the remainder of the quarter, the Committee recommended two $27 billion 2-year notes to be auctioned February 26th and March 26th, respectively. The Committee’s recommendations regarding Treasury bill issuance for the quarter are contained in the attached charts.
For the April-June quarter, recommendations for Treasury borrowing included three $25 billion 2-year notes issued monthly, one $20 billion 3-year note issued 5/15/03, one 5-year note issued 5/15/03, one re-opened 5-year note issued 6/16/03 and one $18 billion 10-year note issued 5/15/03. Additionally, the Committee recommended a 12-day $20 billion cash management bill to be auctioned April 1st.
Timothy W. Jay
Mark B. Werner