Office of Debt Management
Fiscal Year 2012 Q1 Report Table of Contents
I. Fiscal A. Quarterly Tax Receipts p. 4 B. Receipt Base Levels p. 5 C. Ten Largest Outlays p. 6 D. Treasury Net Non-marketable Borrowing p. 8 E. Cumulative Budget Deficits by Fiscal Year p. 9 F. Deficit and Borrowing Estimates p. 10 G. Budget Surplus/Deficit with OMB Forecast p. 11
II. Portfolio Metrics A. Historical and Projected Net Marketable Borrowing p. 13 B. Weighted Average Maturity of Marketable Debt p. 15 C. Recent and Future Portfolio Composition by Issuance Type p. 16 D. Recent and Future Maturity Profile p. 18
III. Demand A. Bid-to-Cover Ratios p. 23 B. Investor Class Auction Awards p. 27 C. Foreign Awards at Auction p. 34 D. Primary Dealer Awards at Auction p. 38
2 Section I: Fiscal
3 Quarterly Tax Receipts
150%
100%
50% Change %%
0% Year over Year
-50%
-100% Jun-11 Jun-10 Jun-09 Jun-08 Jun-07 Jun-06 Jun-05 Jun-04 Jun-03 Jun-02 Sep-11 Sep-10 Sep-09 Sep-08 Sep-07 Sep-06 Sep-05 Sep-04 Sep-03 Sep-02 Dec-11 Dec-10 Dec-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04 Dec-03 Dec-02 Dec-01 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03 Mar-02
Corporate Taxes Non-Withheld Taxes (incl SECA) Withheld Taxes (incl FICA) 4 Receipt Base Levels (12-Month Moving Average)
120
100
80
60 $ bn
40
20
- Jun-11 Jun-10 Jun-09 Jun-08 Jun-07 Jun-06 Jun-05 Jun-04 Jun-03 Jun-02 Sep-11 Sep-10 Sep-09 Sep-08 Sep-07 Sep-06 Sep-05 Sep-04 Sep-03 Sep-02 Dec-11 Dec-10 Dec-09 Dec-08 Dec-07 Dec-06 Dec-05 Dec-04 Dec-03 Dec-02 Dec-01 Mar-11 Mar-10 Mar-09 Mar-08 Mar-07 Mar-06 Mar-05 Mar-04 Mar-03 Mar-02
Individual Income Taxes Corporation Income Taxes Social Insurance Taxes Other
Individual Income Taxes include withheld and non-withheld. Social Insurance Taxes include FICA, SECA, RRTA, UTF Deposits, FUTAand 5 RUIA. Other includes excise taxes, estate and gift taxes, customs duties and miscellaneous receipts. Ten Largest Outlays for FY 2011
1000
900
800
700
600
500 $ bn
400
300
200
100
0 Labor Treasury Education Agriculture ransportation dministration Health and Health ocial Security anagement e of Personnel fense-Military uman Services eterans Affairs TT SS cc ee AA MM V HH D Offi
6 Q1 Levels of Ten Largest Outlays
250
200
150 nn $ b
100
50
0 Labor Treasury Education Agriculture man Services terans Affairs terans ransportation dministration Health and Health ocial Security anagement e of Personnel fense-Military uu ee TT SS cc ee AA MM V H D Offi Q1 FY 2011 Q1 FY 2012 7 Treasury Net Non-Marketable Borrowing
30
20
10
0 $ bn
-10
-20
-30 Q2-02 Q3-02 Q4-02 Q1-03 Q2-03 Q3-03 Q4-03 Q1-04 Q2-04 Q3-04 Q4-04 Q1-05 Q2-05 Q3-05 Q4-05 Q1-06 Q2-06 Q3-06 Q4-06 Q1-07 Q2-07 Q3-07 Q4-07 Q1-08 Q2-08 Q3-08 Q4-08 Q1-09 Q2-09 Q3-09 Q4-09 Q1-10 Q2-10 Q3-10 Q4-10 Q1-11 Q2-11 Q3-11 Q4-11 Q1-12
Fiscal Quarter
Foreign Series State and Local Govt. Series (SLGS) Savings Bonds 8 Cumulative Budget Deficits by Fiscal Year 1,400
1,200
1,000
800 $ bn
600
400
200
0 July June May April March tember cember August vember January ebruary October pp ee oo FF D Se N
FY2010 FY2011 FY2012 9 FY 2012-2014 Deficit and Borrowing Estimates In $ Billion
Primary Dealers* CBO** OMB***
Estimates as of: Jan-12 Aug-11 Sep-11
FY 2012 Deficit Estimate 1,127 973 1,334
FY 2013 Deficit Estimate 899 623 883
FY 2014 Deficit Estimate 737 380 476
FY 2012 Deficit Range 1,000-1,275
FY 2013 Deficit Range 580-1,120
FY 2014 Deficit Range 85-1,037
FY 2012 Marketable Borrowing Range 1,025-1,275
FY 2013 Marketable Borrowing Range 635-1,120
*Based on primary dealer feedback on January 23, 2012. Deficit estimates are averages. **Current law, prior to any Joint Committee actions or sequester. ***Deficit projections from September 2011 – “Living Within Our Means and Investing in the Future”. 10 Budget Surplus/Deficit with OMB Forecast from September 2011 – “Livinggg Within Our Means and Investing in the Future”
500 4%
2% 0
0%
-500 ‐2%
-1,000 ‐4%
‐6% -1,500
‐8%
-2,000 ‐10%
-2,500 ‐12% 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 Fiscal Year OMB Surplus/Deficit in $ bn-(L) OMB Surplus/Deficit as a % of GDP-(R)
11 Projection Section II: Portfolio Metrics
12 Historical and Projected Net Marketable Borrowing Assuming All Issuance Remains Constant 2,000 1,787 1,483
1,104 1,500
1,064 965 898 1,000 787 748 684 $ bn 525 466 500 352 251 169
0
(500) 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 End of Fiscal Year TIPS 7/10/30 2/3/5 Bills OMB De fic it Pro jec tions
Portfolio & SOMA holdings as of 12/30/2011. Assumes current issuance sizes for Bills, Nominal Coupons and TIPS; along with SOMA reinvestment. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. No attempt was made to match future financing needs. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the 13 Future”. Data labels represent net borrowing numbers in billions. Historical and Projected Net Marketable Borrowing Assuming All Issuance Remains Constant, $ Billion
End of Fiscal OMB Deficit Bills 2/3/5 7//0/3010/30 TIPS Net Borro wing Year PjtiProjections 2008 532 106 109 40 787 - 2009 503 732 514 38 1,787 - 2010 (204) 869 783 35 1,483 - 2011 (311) 576 751 88 1,104 - 2012 65 131 790 77 1,064 1,334 2013 0 134 737 93 965 833 2014 0 85 744 70 898 476 2015 0 (28) 708 69 748 525 2016 0 94 534 56 684 589 2017 0 54 354 58 466 506 2018 0 69 393 63 525 482 2019 0 40 256 57 352 511 2020 0 (2) 227 26 251 549 2021 0 (30) 197 2 169 565
Portfolio & SOMA holdings as of 12/30/2011. Assumes current issuance sizes for Bills, Nominal Coupons and TIPS; along with SOMA reinvestment. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. No attempt was made to match future financing needs. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the 14 Future”. Data labels represent net borrowing numbers in billions. Weighted Average Maturity of Marketable Debt
85
80
s) 75 hh
70
65 Maturity (Mont ee 60
55 eighted Averag
WW 50
45
40 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021
Calendar Year
Historical Adjjpust Nominal Coupons to Match Financin g Needs
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2-, 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 15 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Recent and Future Portfolio Composition by Issuance Type, Percent
100%
90%
80%
70%
60% olio ff 50%
% of Port 40%
30%
20%
10%
0% 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 End of Fiscal Year
Bills Nominal Coupons TIPS (princi pal accreted to pro jection date )
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2- , 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 16 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Recent and Future Portfolio Composition by Issuance Type, Percent
TIPS (principal End of Bills Nominal Coupons accreted to Fiscal Year projection date) 2006 21. 3% 69. 5% 92%9.2% 2007 21.6% 68.1% 10.3% 2008 28.5% 61.4% 10.0% 2009 28.5% 63.6% 7.9% 2010 21. 1% 71. 9% 70%7.0% 2011 15.4% 77.3% 7.3% 2012 14.1% 78.7% 7.3% 2013 13.1% 79.3% 7.7% 2014 12. 5% 79. 4% 81%8.1% 2015 12.0% 79.5% 8.5% 2016 11.4% 79.8% 8.8% 2017 11.0% 79.9% 9.1% 2018 10. 6% 80. 0% 94%9.4% 2019 10.2% 80.1% 9.7% 2020 9.8% 80.4% 9.8% 2021 9.5% 80.9% 9.7%
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2-, 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 17 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Recent and Future Maturity Profile, $ Billion
18,000
16,000
14,000
12,000
10,000 nn $ b 8,000
6,000
4,000
2,000
0 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 End of Fiscal Year < 1yr [[,1, 2 ) [[,2, 3 ) [[,3, 5 ) [[,5, 7 ) [[,7, 10 ) >= 10yr
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2- , 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 18 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Recent and Future Maturity Profile, $ Billion
End of < 1yr [1, 2) [2, 3) [3, 5) [5, 7) [7, 10) >= 10yr Fiscal Year 2007 1,582 664 342 551 276 499 627 2008 2,151 710 280 657 318 515 690 2009 2,702 775 666 970 540 691 779 2010 2,563 1,143 872 1,310 918 881 952 2011 2,621 1,273 1,004 1,527 1,146 1,086 1,129 2012 2,824 1,458 1,160 1,923 1,255 1,139 1,208 2013 3,002 1,570 1,182 2,123 1,400 1,181 1,359 2014 3,114 1,518 1,467 2,177 1,361 1,133 1,543 2015 3,063 1,843 1,426 2,273 1,489 1,098 1,674 2016 3, 395 1, 825 1, 505 2, 322 1, 532 1, 081 1, 826 2017 3,370 1,967 1,541 2,500 1,427 1,221 1,999 2018 3,512 1,971 1,609 2,594 1,474 1,252 2,131 2019 3,516 2,036 1,803 2,458 1,615 1,368 2,293 2020 3,602 2,265 1,760 2,546 1,631 1,344 2,530 2021 3,811 2,281 1,627 2,751 1,686 1,370 2,760
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2-, 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 19 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Recent and Future Maturity Profile, Percent
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0% 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 End of Fiscal Year
< 1yr [[,1, 2 ) [[,2, 3 ) [[,3, 5 ) [[,5, 7 ) [[,7, 10 ) >= 10yr
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2- , 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 20 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Recent and Future Maturity Profile, Percent
End of Fiscal < 1yr [1, 2) [2, 3) [3, 5) [5, 7) [7, 10) >= 10yr Year 2007 34.8% 14.6% 7.5% 12.1% 6.1% 11.0% 13.8% 2008 40.4% 13.3% 5.3% 12.3% 6.0% 9.7% 13.0% 2009 37.9% 10.9% 9.3% 13.6% 7.6% 9.7% 10.9% 2010 29.7% 13.2% 10.1% 15.2% 10.6% 10.2% 11.0% 2011 26. 8% 13. 0% 10. 3% 15. 6% 11. 7% 11. 1% 11. 5% 2012 25.8% 13.3% 10.6% 17.5% 11.4% 10.4% 11.0% 2013 25.4% 13.3% 10.0% 18.0% 11.8% 10.0% 11.5% 2014 25.3% 12.3% 11.9% 17.7% 11.1% 9.2% 12.5% 2015 23.8% 14.3% 11.1% 17.7% 11.6% 8.5% 13.0% 2016 25.2% 13.5% 11.2% 17.2% 11.4% 8.0% 13.5% 2017 24.0% 14.0% 11.0% 17.8% 10.2% 8.7% 14.3% 2018 24.1% 13.6% 11.1% 17.8% 10.1% 8.6% 14.7% 2019 23.3% 13.5% 12.0% 16.3% 10.7% 9.1% 15.2% 2020 23. 0% 14. 4% 11. 2% 16. 2% 10. 4% 86%8.6% 16. 1% 2021 23.4% 14.0% 10.0% 16.9% 10.4% 8.4% 16.9%
Portfolio & SOMA holdings as of 12/30/2011. To match OMB’s projected financing needs for the next 10 years, nominal coupon securities (2-, 3-, 5-, 7-, 10-, and 30-year) were adjusted by the same percentage. OMB deficit projections are from Table S-1 of September 2011, “Living Within Our Means and Investing in the Future”. The principal on the TIPS securities were accreted to each projection date based on market ZCIS levels. This scenario does NOT represent any particular course of action that Treasury is expected to follow. Instead, it is intended to 21 demonstrate the basic trajectory of average maturity absent changes to the mix of securities issued by Treasury. Section III: Demand
22 Bid-to-Cover Ratios for Treasury Bills
6
5.5
5
4.5 Ratio 4
3.5 Bid-to-Cover 3
2.5
2
1.5 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11
4-Week (13-week moving average) 13-Week (13-week moving average) 26-Week (13-week moving average) 52-Week (6-month moving average) 23 2-, 3-, and 5-Year Bid-to-Cover Ratios for Nominal Securities (6-Month Moving Average)
3.6
3.4
3.2
3 tio aa
2.8
Bid-to-Cover R 2.6
2.4
222.2
2 ar-11 ar-09 ar-10 ec-10 ec-11 ec-09 ep-11 ep-09 ep-10 un-11 un-09 un-10 JJ JJ JJ SS SS SS DD DD DD MM MM MM
2-Year 3-Year 5-Year 24 Bid-to-Cover Ratios for 7-, 10-, and 30-Year Nominal Securities (6-Month Moving Average)
3.4
3.2
3 atio
2.8 Bid-to-Cover R
2.6
2.4
2.2 ar-11 ar-10 ec-11 ec-09 ec-10 ep-11 ep-09 ep-10 un-11 un-09 un-10 JJ JJ JJ SS SS SS DD DD DD MM MM
7-Year 10-Year 30-Year 25 Bid-to-Cover Ratios for TIPS
3.5
3
2.5 atio RR
2 Bid-to-Cover
1.5
1 Dec-99 Dec-00 Dec-01 Dec-02 Dec-03 Dec-04 Dec-05 Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11
5-Year 10-Year (6-month moving average) 20-Year 30-Year 26 Investor Class Auction Awards: Bills Calendar Year 2011
Other 4.1%
Foreign & International 11.0%
Investment Funds 15.8%
Primary Dealers 59.1%
Other Dealers & Brokers 9.9%
Excludes SOMA add-ons. “Other” includes categories that are each less than 2%, which include Depository Institutions, Individuals, Pension 27 and Insurance. Calendar Year Change in Bill Auction Awards by Investor Class
10%
5%
0% Change
-5%
Calendar Year Calendar -10%
-15%
-20% Dealers Primary Funds Foreign & Investment & Brokers ther Dealers nternational II OO
2011 less 2010 2011 less 2009 2011 less 2008 2011 less 2007 2011 less 2006
Excludes SOMA add-ons. 28 Investor Class Auction Awards: Investor Class Auction Awards: 2-, 3-, and 5-Year Nominal Securities 7-, 10-, and 30-Year Nominal Securities Calendar Year 2011 Calendar Year 2011
Other Other 1.0% 0.7%
Foreign & Foreign & International In terna tiona l 22.6% 24.4%
Primary Dealers 45.5% Primary Dealers Investment 50.6% Funds 15.0% Investment Funds 22.3% Other Dealers Other & Brokers Dealers & 10.8% Brokers 7.0%
Excludes SOMA add-ons. “Other” includes categories that are each less than 2%, which include Depository Institutions, Individuals, Pension 29 and Insurance. Calendar Year Change in 2-, 3-, 5-Year Nominal Securities Auction Awards by Investor Class
15%
10%
5%
Change 0%
-5% Calendar Year Calendar -10%
-15%
-20% Dealers Primary Funds Foreign & Investment & Brokers International International Other Dealers
2011 less 2010 2011 less 2009 2011 less 2008 2011 less 2007 2011 less 2006
Excludes SOMA add-ons. 30 Calendar Year Change in 7-, 10-, and 30-Year Nominal Securities Auction Awards by Investor Class
15%
10%
5%
0% Change
rr -5%
-10%
Calendar Yea -15%
-20%
-25%
-30%
Dealers Primary Funds Foreign & Investment & Brokers International International Other Dealers
2011 less 2010 2011 less 2009 2011 less 2008 2011 less 2007 2011 less 2006
Excludes SOMA add-ons. 31 Investor Class Auction Awards: TIPS Calendar Year 2011
Other 1.4%
Foreign & International 13.0%
Primary Dealers 47.1%
Investment Funds 35.8%
Other Dealers & Brokers 2.7% Excludes SOMA add-ons. “Other” includes categories that are each less than 2%, which include Depository Institutions, Individuals, Pension 32 and Insurance. Calendar Year Change in TIPS Auction Awards by Investor Class 15%
10%
5% r Change aa 0%
Calendar Ye -5%
-10%
-15% Dealers Primary Funds Foreign & Investment & Brokers ther Dealers nternational II OO
2011 less 2010 2011 less 2009 2011 less 2008 2011 less 2007 2011 less 2006
Excludes SOMA add-ons. 33 Foreign Awards of Treasuries at Auction, $ Billion
200
180
160
140
120 ard ($bn) ww
100
80 nthly Private A oo
M 60
40
20
0 ar-11 ar-10 ec-10 ec-11 ec-09 ep-11 ep-09 ep-10 un-11 un-09 un-10 JJ JJ JJ SS SS SS DD DD DD MM MM
Bills 2/3/5 7/10/30 TIPS
Foreign includes both private sector and official institutions. 34 Foreign Awards of Bills at Auction, Percent
25%
20%
Investors 15% nn
10% arded to Foreig ww % A
5%
0% n-11 n-09 n-10 ar-11 ar-10 ec-10 ec-11 ec-09 ep-11 ep-09 ep-10 uu uu uu J J J S S S DD DD DD MM MM
Excludes SOMA add-ons. Foreign includes both private sector and official institutions. 35 Foreign Awards of Nominal Coupons at Auction, Percent
50%
45%
40%
35%
30% Investors nn
25%
20% arded to Foreig ww
% A 15%
10%
5%
0% r-11 r-10 c-10 c-11 c-09 n-11 n-09 n-10 p-11 p-09 p-10 aa aa ee ee ee ee ee ee uu uu uu J J J S S S D D D M M
2/3/5 7/10/30
Excludes SOMA add-ons. Foreign includes both private sector and official institutions. 36 Foreign Awards of TIPS at Auction, Percent
25%
20%
Investors 15% nn
10% warded to Foreig % A
5%
0% ar-11 ar-10 ec-10 ec-11 ec-09 ep-11 ep-09 ep-10 un-11 un-09 un-10 JJ JJ JJ SS SS SS DD DD DD MM MM
5-Year 10-Year 20-Year 30-Year
Excludes SOMA add-ons. Foreign includes both private sector and official institutions. 37 Primary Dealer Awards at Auction, Percent
70%
65% d 60%
55% Amount Awarde
50%
45% otal Competitive otal TT 40% % of
35%
30% Jun-11 Jun-10 Jun-09 Sep-11 Sep-10 Sep-09 Dec-11 Dec-10 Dec-09 Mar-11 Mar-10
4///13/26-Week (13-week movinggg) average) 52-Week (6-month movinggg) average) 2/3/5 (6-month moving average) 7/10/30 (6-month moving average) TIPS (6-month moving average) 38 USTREASURYFLOATINGRATENOTES
February 2012 L A I T N E D I F N O C D N A E T A V I R P Y L T C I R T S The demand backdrop 1
FRN issuance – motivation and estimated benefits 8
Choice of reference indices and sample structures 19 S E T O N E T A R G N I T A O L F Y R U S A E R T S
U 1 The demand backdrop for US Treasuries – whether FRNs or fixed rate debt – should benefit from a structural decline in the stock of high quality assets
Using market-based risk assessment provides Total debt outstanding for G-10 countries with 5Y CDS spreads less than 100bp, as of end-2007 and end-2011; USD a useful view of the altered investment bn environment 20,000 18,000 The stock of bonds issued by sovereigns United States 16,000 with 5Y CDS spreads below 100bp has United Kingdom 14,000 fallen sharply since 2007, excluding the Netherlands 12,000 Japan US (whose CDS spread is below 50bp) 10,000 Italy 8,000 In other words, US sovereign debt is now Germany 6,000 a higher fraction of the “higher quality” France 4,000 sovereign debt universe, likely resulting Canada 2,000 in a supportive demand backdrop for US Belgium - Treasuries End-2007 End-2011
Note: Sweden and Switzerland were excluded due to lack of data. For end-2011, Canada datais as of March 2011,and Japan data is as of September 2011. For European sovereigns, we assume that the amount of bills and non-domestic bonds outstanding is P
O unchanged between 2007 and 2011. R D K C A B D N A M E D E H
T 2 Within the US fixed income markets, the share of Treasuries is growing while the share of other high-quality assets is falling
Net issuance for various fixed income products by year ; $bn
2300 ABS Net of Fed Purchases
1800 BABS
1300 Agency MBS Net of Fed & TSY Purchases 800 AGY Net of Fed Purchases
300 Financial Corps(ex ABS)
-200 Non-Financial Corps
-700 TSY Net of Fed Purchases/Sales
-1200 Net Fixed Income Supply ex Fed & TSY 0 1 2 3 4 5 6 7 8 9 0 F E 0 0 0 0 0 0 0 0 0 0 1 2 1 purchases/sales 0 0 0 0 0 0 0 0 0 0 0 1 1 2 2 2 2 2 2 2 2 2 2 2 0 0 2 2 P O R D K C A B D N A M E D E H
T 3 Will the Basel III LCR requirements trigger increased demand for US Treasuries in general and FRNs in particular?
Market analysts estimated a Liquidity Coverage Ratio of 57% for 30 large bank holding companies, resulting in a gross shortfall of about $500bn - $1Tn depending on mitigation actions undertaken
While Treasury floaters would be attractive for LCR purposes, the net demand for FRNs due to LCR provisions is likely to be modest
Treasury floaters are likely to yield less than liquid assets currently held by banks (fixed rate Treasuries/Agencies/Agency MBS).
While Treasury floaters would be lower duration than current alternatives, many banks are efficient duration hedgers and may be able to achieve higher returns net of hedging cost using the current mix of assets
With the Fed currently paying banks 25bp on excess reserves, banks are likely ignore Treasury floaters unless the yield at least matches IOER.
Also, certain regulatory capital implications of Basel III provisions related to AOCI could, P
O on the margin, incentivize banks to buy FRNs over fixed rate debt R D K C
A However, this is one factor among several driving asset selection, and we expect the B D
N net preference for FRNs over fixed rate debt to be rather modest A M E D E H
T 4 Implementation of Dodd Frank’s central clearing provisions will also create some modest net new demand for high quality collateral such as US Treasuries
Growth of value of total reported and estimated collateral, About 82% of gross credit exposure appears 2000-2010; $bn collateralized already—full implementation of Dodd- 3957 Frank could cause demand for collateral to rise by 4000 about $650bn Reported Estimated 3151 However, this does not directly translate into increased 2934 3000 2649 demand for Treasuries—the ISDA margin survey also indicates that Treasuries and Agencies make up only 2126 2150 1984 about 6% of collateral, which is predominantly 2000 composed of cash 1470 1329 1335 1209 1017 Thus, the incremental demand for USTs due to 854 922 924 1000 719 707 increased collateral requirements stemming from the 437 491 implementation of Dodd-Frank’s central clearing 200 250 289 138 145 provisions could turn out to be modest. 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Caveat – it is possible that the move to hold Source: ISDA Margin Survey 2011 collateral in custodial accounts rather than on a Value of collateral received and delivered by respondents, bilateral basis could lower returns on cash and $mn alter the fraction of USTs in the mix. An increase Collateral Collateral in this fraction could result in considerable received Percent delivered Percent demand for USTs Cash 877,552 81% 715,444 80%
P Government securities 106,697 10% 154,821 17% In addition, the fraction of cash relative to overall O
R US 38,606 4% 48,409 5%
D collateral could decline as short-term rates rise,
K EU 22,943 2% 66,705 7% C leading to higher fractions of other assets such A UK 10,948 1% 13,414 1% B as USTs
D Japan 21,005 2% 17,438 2% N
A Other 13,196 1% 8,854 1%
M Here again, any such incremental demand will
E Others 100,699 9% 29,143 3% D Total collateral 1,084,949 899,408 not discriminate between FRNs and fixed-rate E
H securities
T 5 Money market investors have been increasing Treasury holdings recently thanks to a plunge in supply ex-Treasuries …
Estimate of MMMF Treasury and agency securities Money fund AUM is modestly lower over the past four years, but money holdings, $bn market supply has shrunk by 18%
MMMF’s are significant holders of Treasury and Agency securities MMMF’s hold about $400bn in Treasury and Agency securities each for combined $800bn, representing about 1/3 of AUM In addition, repo holdings backed by Treasury securities and Agency securities (including Agency MBS) are approximately $150bn and $250bn, respectively Preference for T-bills and Agency discount notes, but funds do own coupon securities including about $125bn in Agency FRNs with maturities 2 years or less There could be demand for Treasury floaters yielding more than T- bills, but MMMF preference is likely under 2 year final maturity
Other significant money market investors not bound by rule 2a-7 may have Source: iMoneyNet, Crane Data, J.P. Morgan interest in Treasury floaters as a substitute for lower yielding bank deposits, Note: Agency securities holdings includes discount notes and floating rate notes. money market fund shares, fixed-rate Treasuries and agencies, or other money market instruments. 2a-7 Taxable MMF AUM vs. Money Market Supply, Securities Lending operations of custodial banks. Historically $bn, cumulative since 2007 year-end buyers of floating rate ABS, corporates and agencies with maturities out to 3 years. Market analysts have estimated total investments by these securities lenders exceed $1tn, of which floaters currently account for about $200bn State and local governments. Commonly invest operating and other funds in Treasuries, Agencies and MMMF shares.
P The mortgage GSEs. Actively invest excess cash by selling Fed O
R funds, investing in Treasuries and repo and time deposits with a D
K limited number of financial institutions. Treasury floaters with yields in C
A excess of the Fed funds rate could be attractive. B
D Corporate cash. The recent growth of US corporate cash balances N
A has led to growth in bank deposits, MMMF and other liquid investment M
E strategies. For many firms, Treasury floaters could be an easy to use D alternative to these investments. E Source: iMoneyNet, J.P. Morgan, Bloomberg H
T 6 ... but while this could be an initial tailwind, it is unlikely to be a long-term positive for demand
Over the past 2 years, declining supply of T-Bills and Agency obligations have forced short-term liquidity investors into credit products such as CP/CDs, and any new supply would likely be well received
However, in the longer term, regulation of money-market funds could alter their appeal to investors, subsequently altering their demand profile for any floating rate note issuance.
One offset – to the extent that money market regulation could cause assets to flow into short-term bond funds, those funds could in turn emerge as a demand source for FRNs P O R D K C A B D N A M E D E H
T 7 The demand backdrop 1
FRN issuance – motivation and estimated benefits 8
Choice of reference indices and sample structures 19 S E T O N E T A R G N I T A O L F Y R U S A E R T S
U 8 Revisiting the case to term out debt maturities
Treasury terms out debt in order to reduce debt rollovers as well as the uncertainty regarding future debt service costs. Thus, extending the average maturity of outstanding Treasury debt is most beneficial when current term rates are low and/or the risk of large future changes in Treasury rates are at risk to the upside.
Term Treasury yields are a composite of three things
Expectations of the future path of the Fed Funds rate
Sovereign credit spreads, and
Term premium S T I By replacing T-Bill issuance with nominal fixed rate Treasury issuance, the Treasury locks in: F E N E
B The current path of the expected increase in Fed Funds (currently benign) D E T
A Current credit costs as reflected in the current sovereign CDS credit spread (currently low) M I T S
E The current yield curve term premium (currently low) D N A N O I T A V I T O M – E C N A U S S I N R
F 9 FRNs can help reduce the debt roll-over burden, without paying the yield curve term premium, but at the expense of retaining exposure to rising interest rates and credit costs
By issuing FRNs with a term of (say) 2 years, Treasury can capture the low funding costs of T-bills, while effectively terming out issuance and reducing roll-over requirements As an example, monthly issuance of (say) $10bn of 2-year FRNs raises $240bn over two years, and increases the rollover burden by $10bn/month once the auction cycle is fully phased in (i.e., after two years)
Issuing an equivalent $240bn of securities by increasing 3 and 6 month bill offerings could boost the monthly roll-over requirement by $40-80bn.
However, by choosing to substitute T-Bill issuance with FRNs rather than with fixed rate debt of S T
I similar maturity, the Treasury: F E N
E Does not lock in a future path of short rates, and instead takes on that risk in exchange for B D
E not paying the (usually positive) interest rate risk premium priced into the curve T A M I It does lock in term funding, and thus takes advantage of its currently low sovereign CDS T S
E spread. D N A However, it may retain exposure to a widening in its sovereign CDS spread if its floating debt N O I
T costs are indexed to some benchmark that is affected by it (e.g., T-bill yields) A V I T O M – E C N A U S S I N R
F 10 The benefits of issuing Floating Rate Notes versus fixed-rate debt
Trailing hypothetical savings (relative to a 2Y fixed rate note) Trailing hypothetical savings (relative to a 5Y fixed rate note) from issuing a 2Y FRN indexed to 6-month T-bill yields at a zero from issuing a 5Y FRN indexed to 6-month T-bill yields at a zero spread, versus the trailing change in the fed funds rate over the spread, versus the trailing change in the fed funds rate over the 2-year period 5-year period 3.0 -6 5.0 -6 2yr - 6mo 2yr Change in Fed Funds 5yr - 6mo -5 2.5 5yr Change in Fed Funds -4 4.0 2.0 -4 ) ) r 3.0 -3 r y 1.5 -2 y N N 2 5 ( ( R R
e e F F -2 t t
2.0 a 1.0 a g g n n R R i i
0 -1 u u s s s s d 0.5 d s s n 1.0 n I I
u 0 u f f F F o o
0.0 2 S s s d d g g e e T 0.0 1 n n I F F i i
F v -0.5 v n n i i a a E
2 4 S S e e
N g -1.0 -1.0 g E % % n 3 n a a B h h C 6-1.5 C D 4-2.0 E 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 T 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 A M I
T FRNs allow Treasury to term out its funding while lessening average funding costs in the long run S E D
N Given typically positive term premium in the yield curve, the realization of short rates over a fixed term A
N (say, 2- or 5-years) will on average be lower than the ex-ante term rate O I T A V
I Thus, issuing FRNs—assuming the issuance spread is not too high, and assuming that FRNs substitute T
O for fixed rate notes—can produce cost savings on average. This has historically been the case, as shown M
– in the charts above E C N
A Last, to the extent that UST FRNs draw in new incremental demand from investors who cannot hedge the U S
S interest rate risk in fixed rate Treasuries, this should result in an aggregate benefit to Treasury I N R
F 11 Savings depend less on the choice of the reference rate index, and more on the tenor of issuance that FRNs will replace - issuing FRNs instead of Bills will yield maturity extension benefits but not cost reduction 3-month T-bill yield and ex-post 3-month average of GC index (GCFRTSY Index) versus cost/savings of floater FRNs – whether indexed to bill yields or an overnight index such as fed funds or GCF – would have 0.25 3MT-bill yield (%;left axis) 20 3Mavg GC(%;left axis) historically produced largely similar cost savings Differential (bp, right axis) 0.20 15 Charts alongside show that the rolling differential between GC/fed funds with respect to bills is stable 0.15 10 and relatively small. Thus, savings from issuing FRNs might be expected to be less dependent on the 0.10 5 choice of index
0.05 0 Savings with respect to rolling bill issuance would S T I
F be expected to be negative; the price of terming out
E -50.00 N debt while still paying short term rates will be E Oct09 Feb 10 May 10 Aug 10 Dec 10 Mar 11 Jun 11 Sep 11 B reflected in the spread over bill yields that Treasury D 3-month T-bill yield and ex-post 3-month average of effective E
T Fed funds (FEDL01 Index) versus cost/savings of floater will need to pay on an FRN, which is discussed later. A M I T 0.20 15 S E D N A
N 0.15 10 O I T A V I
T 0.10 5 O M – E
C 0.05 0
N 3M T-billyield (%;left axis) A
U 3M avg FF (%; left axis) S
S Differential (bp, right axis) I 0.00 -5 N
R Oct09 Feb 10 May 10 Aug 10 Dec 10 Mar 11 Jun 11 Sep 11
F 12 Estimating the forward-looking benefits to Treasury from FRN issuance
Three factors determine the costs/savings of FRNs versus fixed-rate debt
The pricing spread – e.g., what fixed spread over (say) floating 3-month bill yields Treasury pays to issue a par priced FRN
The level of interest rate risk premium at time of issuance
The Fed’s monetary policy stance—savings are likely to be greater when the change in the funds rate is negative, and especially when such change is more negative than the expectations priced into forwards S T I The first of these – pricing spreads – will likely not be onerous enough to materially reduce the F E
N savings from issuing FRNs E B D E
T Even if FRNS are initially less liquid, market participants will likely arbitrage away any A M
I significant differences from the spread implied by fixed rate note asset swap levels, thanks T S
E to a highly developed interest rate derivatives market D N A Experience in other fixed income product sectors that have fixed rate notes as well as N O I
T FRNs suggests that this is historically true A V I T O M – E C N A U S S I N R
F 13 A closer look at yield curve term premium
Term premium itself may be thought of as being composed of two parts
the cost of maturity extension, as well as
the premium for the privilege of fixing funding costs, which we may think of as just the interest rate risk premium
We may estimate the former by looking at the asset swap spread of term Treasury debt over Bills – e.g., if 2Y notes swap to 3M bill yields + 8bp to term, then 8bp represents the cost of maturity extension S T I In near-zero rate regimes, we may estimate the interest rate risk premium via cap costs F E N E
B It is reasonable to assume that the risk to short-rates is one-sided, there is similarity D E
T between the cost of an at-the-money cap on short rates (expressed in yield terms) and the A M
I portion of term premium attributable to the uncertainty in short rates T S E
D Estimation is subject to basis risks, since the cap market is based on Libor and not OIS N A forwards; Libor cap costs likely overestimate interest rate risk premium currently, because N O I
T of higher Libor rate volatility A V I T
O FRNs will incur the costs associated with maturity extension, while saving on interest rate risk M
– premium (relative to issuing term debt) E C N A U S S I N R
F 14 Is this the best time in the cycle for FRN issuance from Treasury’s perspective?
Rolling 2-year savings from issuing a 2-year FRN linked to Estimated interest rate risk premium* by maturity; bp of yield 6-month T-bills relative to issuing fixed-rate notes versus 2Y 110 interest rate risk premium; bp of yield 2Y 100 240 3Y Trailing cost savings 90 5Y 220 Savings attributable to term premium 80 200 180 70 160 60 140 50 120 40 100 30 80 S
T 20 60 I F
E 10 40 N
E 20
B Jan 10 Jul 10 Jan 11 Jul 11 Jan 12
D Jul 10 Jan 11 Jul 11 Jan 12 E
T * Estimated as the cost of an at-the-money cap on short rates, in yield terms. This is premised on the notion that in near-zero policy rate regimes, the one-sided nature of policy rate A risk makes interest rate risk premium comparable to cap costs. M I T S E Current levels of interest rate risk premium are low, and the risk to the expected path of policy rates is likely asymmetrically D
N biased higher A N O
I The Fed’s commitment to low rates until late-2014, as well as its new communications policy of projecting a path for T
A the funds rate, have already lowered interest rate risk premium, and this is unlikely to rise for several years. V I T
O Given de minimis monetary policy rates currently, the next move by the Fed is only likely to take the funds rate higher M –
E With interest rate risk premium currently near all time lows, savings are likely to be marginal C N A U S S I N R
F 15 What about the cost – where might Treasury FRNs price?
Estimated pricing spread on a hypothetical 2Y FRN linked to Regardless of the choice of floating rate index used to 3M Treasury bills*; bp specify the coupons in any potential FRN issued by Treasury, it is useful to consider the par priced FRN 25 spread-over-bills for purposes of analysis Estimated pricing spread; bp 20 Average = 11.7 I.e., if the basis swap market is used to transform the FRN into a floater linked to bill yields, what 15 would the pricing spread be for a par priced FRN at time of issuance 10 This represents the direct “cost” incurred by 5 Treasury, for the sole purpose of terming out its
S debt T I 0 F
E It is reasonable to assume that this will not fall N E
B -5 below zero; should it do so, Treasury has a strong
D incentive to issue FRNs in place of T-bills E Jul 10 Jan 11 Jul 11 Jan 12 T A
M I The chart alongside shows the hypothetical pricing T
S * Assumes that FRNs will price at the same asset swap level as a maturity spread, if FRNs were to price at the same asset swap E matched bullet Treasury.
D spread as a maturity matched fixed rate Treasury note. N
A This is a reasonable estimate of where FRNs might price N O I T A V I T O M – E C N A U S S I N R
F 16 A stylized illustration of the relationship between pricing spreads and the attractiveness to Treasury
A schematic illustration of the attractiveness of issuing FRNs from Treasury’s perspective, for various pricing spreads (versus a T-bill floating index) Bills + maturity extension premium Not attractive + interest rate risk FRNs deliver maturity extension at a higher premium cost than term fixed-rate debt
Likely pricing spread = bills + Attractive maturity extension FRNs still deliver savings from term premium S T
I premium but give some of it back for the privilege of F E
N extension E B D E T
A Bills + 0
M Very attractive I T
S FRNs deliver maturity extension as well as E
D cost savings relative to term debt or rolling N
A bills N O I T A V I T O M – E C N A U S S I N R
F 17 The impact of FRN issuance on the weighted average maturity of Treasury debt will likely be relatively modest in the initial years
We consider 3 stylized issuance policies: Treasury issues FRNs at the expense of reduced issuance in (i) T-bills, (ii) matched maturity fixed rate issuance, or (iii) a reduction in Projected WAM in different scenarios; months Base case: matched- Nominal coupon sizes fixed rate coupon Treasury issuance in proportion to current Bill issuance is Date maturity nominal coupon are reduced gross issuance reduced to issue sizes are reduced to issue proportionally across the floaters Replacing matched maturity fixed rate debt does not alter floaters maturity stack WAM, but the other two policies will alter WAM Sep-12 63.4 63.5 63.4 Sep-13 65.4 65.5 64.8 Issuing FRNs wholly at the expense of bills will have Sep-14 68.3 68.6 67.1 the greatest impact on WAM May-15 70.0 70.3 68.4
Assumes $50bn in annual FRN issuance beginning in Note: The base case assumes that coupon sizes are unchanged while net bill issuance adjusts May 2012 ($25bn in 2s, $15bn in 3s and $10bn in 5s), as the budget deficit increases/decreases. Also, FRN issuance is assumed to occur at the S
T expense of maturity matched fixed rate coupon issuance .
I which is increased to $100bn annually by 2014 F E
N The increase in WAM is likely to be modest even if E B done wholly at the expense of T-bills D
E Historical and projected share of T-bills as %ge of T
A Historical and projected WAM of marketable Treasury marketable Treasury debt based on scenarios #1 and #2 M
I debt based on scenarios #1 and #2 in table above in table above T S E 35%
D 75
N All from A bills N 70 30% Base case/ O I matched T
A maturity V 65 25% I nominals T O
M 60 20% – E C
N 55 Base case/ 15% A matched- U
S maturity S 50 All from I nominals 10%
N bills R F 45 18 5% Dec80 Nov87 Sep94 Aug01 Jun08 May15 Dec94 Jan99 Feb03 Mar07 Apr11 May15 The demand backdrop 1
FRN issuance – motivation and estimated benefits 8
Choice of reference indices and sample structures 19 S E T O N E T A R G N I T A O L F Y R U S A E R T S
U 19 The majority of the Agency floater market is linked to Libor or Fed funds
Distribution by original Distribution by underlying maturity (years) benchmark type About $153bn of Agency floaters are outstanding 0-1 0.2% 1M Libor 64.8% 1-2 16.7% currently, which is about 7.2% of the total Agency FF Effective 25.9% 2-3 75.5% debt market 3-4 4.9% 3M Libor 5.4% 4-5 0.3% Prime rate 2.8% Most of these structures reference Libor or Fed 5-6 1.5% 3M T-bill 0.7% funds as an index 6-7 0.1% CPI 0.1% 7-8 0.0% Demand for floaters linked to Libor and FF 8-9 0.0% Distribution by reset may be due in part to the deep and liquid frequency 10-11 0.1% derivatives markets based on these S
E 12-13 0.1% Monthly 64.9% R indices, allowing for efficient hedging of U 15-16 0.4% T Daily 28.6%
C risks U 20-21 0.1% Quaterly 5.6% R
T >30 0.2% S Weekly 0.7% These indices have disadvantages too – E
L Semi-annually 0.2%
P exposure to banking system credit risk (in M
A the case of Libor), and the Fed funds S FNMA, FHLMC and FHLB floaters outstanding; $bn
D effective rate is distorted by IOER and N A 350 318
S related inefficiencies E C I 300 267 D 250 N I 250 214 E C
N 200 E
R 152
E 150 137
F 125 123
E 98 R 100
F 70
O 45
E 50 C I
O 0 H
C 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 20 The corporate floater market is also predominantly linked to Libor as an index rate
Distribution by original Distribution by underlying maturity (years) benchmark type High grade corporate floaters outstanding*; $bn
0-1 3.42% 3MLibor 96.10% 550 509 1-2 23.46% 1MLibor 3.38% 500 2-3 34.89% FF Effective 0.38% 444 3-4 1.86% 450 6MLibor 0.09% 4-5 13.76% 392 400 5-6 2.03% Prime Rate 0.04% 6-7 5.24% 3M T-bill 0.01% 350 S
E 7-8 1.50% R 300
U Distribution by reset 267
T 8-9 0.28% 256
C frequency
U 250
R 9-10 12.02% 212 216 T Quarterly 96.13% S 10-11 0.22% 200 E
L Monthly 3.39% 2005 2006 2007 2008 2009 2010 2011 P 11-12 0.24% M Daily 0.42% A
S 19-20 0.63% * Includes only index-eligible floaters. (Floaters with <$300mn outstanding and less than D Semi-annually 0.05%
N 12-13 0.03% one year to maturity are excluded.) A Weekly 0.01% S 28-29 0.00% E C I 29-30 0.32% D N I 30-31 0.09% E C N E R E F E R F O E C I O H
C 21 Possible Options for a Reference rate index Diversify Reduce Already Will likely Decrease Will likely Treasury's basis risk used in appeal to Index Treasury's appeal to retail Additional Notes funding in the existing money market rollover risk investors costs system markets investors Provides for a variety of reset frequencies from overnight to 12-month. More attractive to some investors as more closely linked to their liabilities. Subject to banking system funding pressures. Diversification LIBOR yes partially yes yes yes yes benefits will be somewhat limited, since issues around sovereign credit concerns would likely also result in higher LIBOR. Nonetheless, with only 3 US banks in the USD Libor panel, some degree of diversification is likely.
Typically indexed to weekly auction clearing rates. Treasury could also explore daily resetting to secondary/ constant maturity T-bills data released by the Fed, butthis could reduce transparency. Would S
E enable frequent resets keeping price of floater close to par and thus R
U making it more attractive to investor types that value price stability such T
C T-bills yes no yes yes yes yes as money market funds. Will be of interest to investors who typically roll U
R T-bills. While this market exists, very small percentage of Agency and T
S Corporate FRNs are linked to T-bills (0.7% and 0.1%, respectively). E
L Changes in Bill auction schedule would result in changes in floaters in P
M which resets are linked to bill auctions. Not significantly different than T- A
S Bills, risking cannibalization of T-Bill demand. D N
A Daily resets. Would enable daily resets keeping price of floater close to
S par and thus making it more attractive to investor types that value price E Fed C stability such as money market funds. Predictably low in current rate I funds eff. yes yes yes yes partially yes D environment. Subject to changes in the Fed's monetary policy. Future N
I rate ofFed Funds marketis uncertain, as future ofGSEs and Fed chosen E
C policy tool is uncertain. N E
R Fed
E A highly visible rate, but would will be hard to hedge given basis risk F funds yes yes no no yes yes E with tradable markets.
R target F
O GCF Could enhance Repo market itself. Could decrease demand for repo yes no yes no partially yes E repo rate product and indirectly for nominal Treasuries. C I O H
C 22 Comments on structural characteristics of FRNs
Issuance in the existing floater market has been concentrated in maturities 5-years and in. More than 92% of the Agency market and 61% of the corporate floater market were issued with an original maturity of less than 3-years.
Having a more frequent reset frequency will result in lower interest rate duration and thus lower price vol, and could be more desirable to investors seeking stable value assets. Daily and Monthly resets are more typical in Agency FRNs, while quarterly resets are more typical in Corporate FRNs
Treasury should floor coupons payments at zero
This does note necessarily mean a zero floor on observations of the floating index rate. For instance, S E
R a note paying semiannual coupons, with daily accruals could result in negative observations on one or U T
C more days between coupon payment dates. Only the ultimate coupon payment needs to be floored at U R
T zero S E L P M A S D N A S E C I D N I E C N E R E F E R F O E C I O H
C 23 Choice of index rate and final maturity could also be a determinant of incremental demand for the product
Depending on final maturity there could be significant demand 1-week average of GCF Treasury index versus 1-week for a Treasury Floater Indexed to either overnight fed funds or average of par amount traded; GC Repo, primarily from Money-market funds and liquidity % $bn portfolios.
0.30 Index level Par amount traded 250 Demand for an FRN linked to either of these indices would 0.25 likely be driven by: 200 0.20 2a-7 Money Market Funds (if the contingent final 0.15 150 maturity is less than 397 days)
0.10 Corporate Treasury accounts not set-up to trade repo S 100 E
R 0.05
U Investment funds / Foreign accounts looking for a high T
C 0.00 50 quality floating rate asset U 0 1 0 1 9 0 0 1 1 1 1 1 1 0 1 1 1 1
R
y y b b v g v g v T a a e e o u o u o S F F
N A N A N The basis between GCF and fed funds is small on a smoothed M M E L GC Index (GCFRTSY Index) versus effective Fed funds basis, so returns on an FRN linked to either would likely be P
M (FEDL01 Index); 1-week moving average; % similar A S
D 0.30 Both indices are amenable to daily resets, which would produce
N GC index A Fed funds very low interest rate duration risk (but not spread duration), S 0.25 E and thus lower price volatility. However, ratings agency C I
D guidelines favor indices that are more than 95% correlated to
N 0.20 I either fed funds or Libor, possibly making fed funds a better E C
N 0.15 choice E R E
F 0.10 E R
F 0.05 O E C
I 0.00 O
H Jul 10 Jan 11 Jul 11 Jan 12 C 24 Description of a sample 2Y FRN linked to 6M T-bill yields
Characteristics Hypothetical annualized funding cost for a 2-year Treasury FRN linked to 6-month T-bill yields versus actual 2-year Treasury yield; % Maturity: 2-years 6 Hypotheticalannualizedfundingcostfor2Y FRNlinkedto 6M T- Coupon: Floating bills 5 2YTreasuryyield Payment Frequency: Semi- Annual 4
Reference Index: The average 3 auction yield of 6-mo T-bill S
E Auctions during reference period 2 R U T C
U Day Count: Act / Act 1 R T S
E 0 L 1 1 2 2 3 3 4 4 5 5 6 6 7 7 8 8 9 9 2 3 4 5 6 7 8 9 P 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0
r r r r r r r r c c c c c c c c c M g g g g g g g g g p p p p p p p p e e e e e e e e e u u u u u u u u u A A A A A A A A A A D A D A D A D A D A D A D A D A D S D N A S E C I D N I E C N E R E F E R F O E C I O H
C 25 Description of a sample 2Y FRN linked to the overnight fed funds and GCF rate indices GC Index Floater Characteristics Average Fed funds Floater Characteristics Maturity: 2-years Maturity: 2-years Coupon: Floating Coupon: Floating Payment Frequency: Semi-Annual Payment Frequency: Semi-Annual Reference Index: GCFRTSY
S other depository institutions overnight.
E Average current daily volume is approximately R
U $150bn. Day Count: Act / Act T C
U Day Count: Act / Act R T S E L P M A S D N A S E C I D N I E C N E R E F E R F O E C I O H
C 26 Conclusions
The demand backdrop is currently favorable for US Treasuries, but it is prudent for Treasury to consider broadening its issuance strategy to draw in more incremental demand
Floating Rate Notes issued by Treasury are one such avenue, and could be attractive to money funds, investors seeking bonds with low duration risk, and possibly banks seeking to mitigate the accounting effects of some of the Basel III provisions
That said, any such incremental demand is likely to be modest in the near term
The current timing does not appear ideal, although initiating an issuance program now could allow Treasury to position itself to capitalize on a more favorable market environment
Term premium in the yield curve is currently at all time lows, and the risk to the path of the funds rate is biased asymmetrically towards higher rates since further Fed easing is not possible S E
R However, initiating a program now could help position Treasury for a future environment marked by higher term premia U T C
U The choice of a floating rate index must balance the need for simplicity and transparency with the need to diversify Treasury’s R
T funding risk S E
L Indexing to T-bills offers simplicity and transparency, but does not fully diversify funding cost risk P M A
S GCF offers the prospect of daily resets and very low duration risk, but is a more complex choice that is mostly unknown
D to retail investors N A
S Libor offers simplicity & transparency, but this index creates exposure to banking sector credit for Treasury E C I
D Indexing to average Fed funds rate offers simplicity and transparency, overnight reset frequency, and a viable N I derivatives market for risk management. In addition, a reasonably well developed FRN market exists in other sectors. Its E C
N appeal to retail investors needs to be further studied E R E F E R F O E C I O H
C 27