February 1, 2011
The Committee convened in closed session at the Hay Adams Hotel at 11:30 a.m. All Committee members were present except for Keith Anderson. Assistant Secretary for Financial Markets Mary Miller, Deputy Assistant Secretary (DAS) for Federal Finance Matthew Rutherford and Director of the Office of Debt Management Colin Kim welcomed the Committee including the newest members of the Committee Jason Cummins and Curtis Arledge. Other members of Treasury staff included Fred Pietrangeli, Jennifer Imler, Mike Dai and Bret Hester. Federal Reserve Bank of New York members Brian Sack and Joshua Frost were also present.
DAS Rutherford opened with a discussion about the recent trends in the economy and tax receipts.
On the economic front, Rutherford noted that real GDP has expanded for six consecutive quarters. Although the pace of growth remains moderate, consumer spending and business investment continue to post solid gains, and recent data suggests that the economy is poised to strengthen further.
The improvements in economic growth have led to a modest improvement in tax receipts. On a year-over-year basis, various key components of tax receipts have increased between 6 and 17 percent. He noted that going forward some moderation in individual tax receipts collected is expected, largely due to the tax legislation that was passed in December 2010. However, further improvements in economic growth resulting from the package would limit the ultimate cost of the package.
The repayment of TARP investments continues to have a positive impact on Treasury’s borrowing. Over the last quarter, Treasury announced nearly $40 billion of repayments, dividends, and interest. More is expected given Treasury’s disposition of its investments in AIG. Treasury’s estimate of the ultimate cost of TARP has now fallen to $28 billion as of October 2010, significantly below CBO’s March 2010 estimate of $109 billion.
Since the beginning of FY 2011, there have been modest improvements in the budget deficit. Over the first three months of FY 2011, the budget deficit printed at $371 billion, below the $388 billion observed over the same time period in FY 2010. Rutherford noted that the average primary dealer budget deficit estimate for FY 2011 was $1.36 trillion, below CBO’s estimate of $1.48 trillion. He noted that the Administration’s budget will be released in the coming weeks.
Rutherford then addressed the statutory debt limit. As of January 31, 2011, Treasury was $215 billion below the debt limit of $14.294 trillion. He noted that the Secretary had recently sent a letter to Congress indicating that the debt limit would be reached between March 31 and May 16. However, Rutherford underscored that the dates could shift modestly in the coming weeks and months, as there is a considerable amount of uncertainty surrounding the outlook for the economy, receipts and expenditures. This uncertainty is increased during the April tax season, which poses considerable forecasting challenges.
Nonetheless, DAS Rutherford highlighted that Treasury is confident that Congress will raise the debt limit in a timely fashion.
The presentation then turned to auction demand. Treasury remains very pleased by the performance of recent auctions. Coverage remains well above the pre-crisis average, with auctions being covered at a 3 to 1 level in FY 2011. Treasury’s investor class data shows that demand has been well distributed amongst a fairly diverse set of investors. At coupon auctions in FY 2011, primary dealers’ share of the auctions have been approximately 47 percent, while foreign accounts have been allocated 22 percent and domestic investment funds have been awarded 17 percent. The residual is made up of smaller broker-dealers and the Federal Reserve’s System Open Market Account (SOMA).
Director Kim then discussed recent changes in the Treasury portfolio. He noted that Treasury bills have fallen as a percentage of the portfolio to 20 percent, the lowest level observed since April 1999. Moreover, this trend will continue in light of Treasury’s recent announcement that it would reduce the size of the Supplementary Financing Program (SFP) from $200 billion to $5 billion. This action was taken to provide flexibility to debt managers, given the proximity to the statutory debt limit. Going forward, Treasury retains the flexibility to increase the SFP.
Kim went on to note that nominal coupons as a percentage of the portfolio have risen to 73 percent, above the long-term average of 69 percent. This is consistent with Treasury’s goal to continue to extend the average maturity of outstanding debt. The average maturity has risen to 59 months, above the long-term average of 58 months. Absent the SFP, the average maturity of the debt is closer to 60 months. Treasury expects this figure to continue to gradually extend further in the coming year.
TIPS remain steady as a percentage of the portfolio at 7 percent. Kim indicated that Treasury has been pleased by the performance of TIPS auctions over the past year, particularly in light of the increase in issuance. Going forward, Treasury expects to issue over $100 billion in TIPS in 2011. No further changes to the program are expected in the near future.
Kim also briefly discussed the cost of the TIPS program. There have been a number of studies over the years, but Kim noted that on an ex-post basis, the cumulative cost of the TIPS program has fallen substantially. Today this number stands at $5 billion and it is trending lower.
Finally, Rutherford concluded with a brief discussion about the budget and longer-term fiscal outlook. He reiterated that the President’s budget would be released in the coming weeks. However, he noted that the President’s State of the Union address previewed some of the important fiscal measures that could be taken, including (i) a 5-year non-security discretionary freeze, (ii) defense spending cuts, and (iii) reform of the corporate tax code to eliminate special interest loopholes and to lower rates.
A brief discussion ensued following Rutherford’s presentation. The Committee concluded that the Treasury issuance calendar was well positioned through June and recommended no changes to coupon issuance over the next two quarters. While the reduction of SFP issuance would normally create concerns about dislocations in the bill market, seasonal increases in bill issuance heading into the tax season should mitigate those concerns. The committee recommended that Treasury wait until the second half of the year before considering any changes to coupon issuance.
Finally, the committee debated the benefits versus cost of extending the average maturity of the U.S. Treasury debt portfolio. The committee was pleased with the degree to which Treasury has been able to extend the average maturity to date, but noted that the pace of that extension would decelerate going forward. Members concluded that this topic merited further discussion at future TBAC meetings.
The Committee then addressed the second charge, which asked for comments on various potential instruments that Treasury might consider in the future. Rutherford noted at the start of the discussion that Treasury periodically surveys the borrowing advisory committee on this topic, and noted that Treasury always welcomes new ideas to ensure that Treasury meets its goal of financing the government at the lowest cost over time.
The presenting member began by providing an overview of the current supply and demand characteristics in the Treasury market. With regard to demand, the member noted that foreign ownership Treasury debt was significant, with ownership concentrated amongst a few key foreign investors. Expanding the Treasury investor base to include more domestic investors by offering new products is desirable and would reduce overall funding risk. The presenting member noted that other sovereigns’ debt (Italy, Japan, and the UK) is largely funded by domestic investors. The member further noted that it was important to avoid cannibalizing the current auction process and that any new products should add to demand.
On the supply side, opportunities to expand the investor base have developed due to market dislocations following the financial crisis. A decline in GSE debt issuance, the wind-down of bank debt issued under the Temporary Liquidity Guarantee Program (TLGP), dislocation in the municipal market, and the contraction of the commercial paper market have resulted in a shortage of high quality assets.
Opportunities for Treasury also exist because of pending regulatory and legislative developments. Provisions contained in Dodd-Frank, Financial Accounting Standards Board (FASB) pension reform and the Basel III Liquidity Coverage Ratio (LCR) will potentially create greater demand for long-dated, high-quality, liquid products.
The member recommended that Treasury develop products that target the needs of three different investor classes, specifically banks, pension funds/insurers, and retail investors. The member estimated that demand from these three investor classes could total $2.4 trillion over the next 5-years, if the right products were offered.
The presentation next discussed a variety of specific securities and debt management techniques that could potentially aid Treasury in achieving its goal of expanding the investor base and financing the government at the lowest cost over time.
The presenting member first discussed “ultra-long” bond issuance, which were defined as securities issued with a tenor of 40-, 50- and/or 100-years. The member noted significant demand exists for high-quality, long-duration bonds from entities with longer-dated liabilities. It was noted that duration tapers off rapidly with maturity and is dependent on the underlying coupon on the bond. As a result, liability-driven investors would likely use the STRIPS market to capture additional duration exposure.
The presenting member then discussed increasing the U.S. Treasury investor base through callable issuance. The presenter noted the emerging gap between demand and supply in this market, driven by less GSE callable debt and MBS issuance. The member added that Treasuries are a relatively close substitute for Agencies, especially in the 2- to 5-year maturity ranges with 6-month to 1-year lock outs. According to the member, accounts that buy callable product include domestic banks, foreign banks, state and local governments, fund managers, insurance companies, pension funds and foreign investors. The presenting member noted that demand may exist for longer-maturity callable paper. This space is currently occupied by corporate names carrying ratings of BBB or lower.
Examining current pricing for Agency product, the presenter estimated it would cost Treasury an additional 18 basis points to issue a 5-year bond callable in 1-year and an additional 8 basis points to issue a 2-year bond callable in 6-months.
While this strategy would give the Treasury additional optionality in managing its debt and potentially increase its investor base, the presenting member remarked that demand for callable product tends to decrease if investors expect interest rates to increase. If market volatility increased or we entered a rising rate environment, the member mentioned that the Treasury would have to offer higher yield enhancements to maintain a regular issuance program.
The discussion then turned to potential demand for new money market instruments. The presenter concluded that new regulations may be creating room for increased bill and callable issuance to fill the emerging gap between Money Market Mutual Funds and issuers. Regarding bonds targeted for individual investors, the member concluded that increasing household ownership of Treasuries has the potential to broaden the investor base significantly.
The discussion turned to floating rate securities with short-dated reference rates such as bonds indexed to the 6-month T-bill rate with a semiannual reset. While such instruments would not protect Treasury against increased debt service costs in a rising rate environment, they would reduce rollover risks. CMT-style floaters, which have a reference rate that is generally on a maturity much longer than the reset period, have had mixed success in other countries due to the complexity of pricing.
GDP-linked bonds were noted to be an interesting product for which more research needs to be done to assess their potential. A discussion ensued about the possible increased demand for TIPS from separating the final cash flow of TIPS into the unadjusted principal and the inflation accrual components in order to create a “pure inflation” component.
Turning next to debt management tools, the presenting member noted the potential for new maturity series such as a 20-year security to complete gaps in the Treasury maturity profile. Buybacks were noted to be effective in reducing “peaks” in maturities and smoothing out the debt profile. The pros and cons of using interest rate derivatives as a tool for liability management were discussed.
An energetic discussion followed regarding the merits of different debt instruments discussed in the presentation. The committee concluded that this topic deserved further review.
The meeting adjourned at 1:00 PM.
The Committee reconvened at the Department of the Treasury at 5:00 p.m. All of the Committee members were present except for Keith Anderson. The Chairman presented the Committee report to Secretary Geithner.
A brief discussion followed the Chairman's presentation but did not raise significant questions regarding the report's content.
The Committee then reviewed the financing for the remainder of the October through December quarter (see attached)
The meeting adjourned at 5:45 p.m.
Deputy Assistant Secretary for Federal Finance
United States Department of the Treasury
February 1, 2011
Matthew E. Zames, Chairman
Treasury Borrowing Advisory Committee
Of The Securities Industry and Financial Markets Association
February 1, 2011
Ashok Varadhan, Vice Chairman
Treasury Borrowing Advisory Committee
Of The Securities Industry and Financial Markets Association
February 1, 2011
Treasury Borrowing Advisory Committee Quarterly Meeting
Committee Charge – February 1, 2010
Taking into consideration Treasury’s short, intermediate, and long-term financing requirements, as well as uncertainties about the economy and revenue outlook for the next few quarters, what changes to Treasury’s coupon auctions do you recommend at this time, if any?
Debt Management Tools and Strategy
Treasury continually seeks ways to minimize borrowing costs, better manage its liability profile, enhance market liquidity, and expand the investor base in Treasury securities. In light of these objectives, we would like the Committee to comment on the potential costs and benefits of new Treasury products that might assist Treasury in achieving some or all of these objectives. In addition, are there any other debt management tools that Treasury should consider? In answering the question, please review the practices and products employed by debt management authorities around the world.
Financing this Quarter
We would like the Committee’s advice on the following:
- The composition of Treasury notes and bonds to refund approximately $21.8 billion of privately held notes maturing on February 15, 2011.
- The composition of Treasury marketable financing for the remainder of the January 2011- March 2011 quarter, including cash management bills.
- The composition of Treasury marketable financing for the April 2011-June 2011 quarter, including cash management bills.
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