With Bloomberg recently writing articles such as "Mnuchin to Wall Street: U.S. Is Serious About Ultra-Long Bonds", "Mnuchin Says Ultra-Long U.S. Bonds Can Absolutely Make Sense" and "Wall Street Sees Treasury Paying Up for Ultra-Long Bond Issuance", there was a tangible buildup of confusion and excitement that the US Treasury under Steven Mnuchin may follow in Europe's footsteps and announced 50, if not 100 year Treasurys in the near future. As such, today's quarterly refunding announcement by the Treasury Borrowing Advisory Committee - which met yesterday at the Hay Adams Hotel at 9:00 a.m. - was keenly watched to see whether Wall Street would agree or endorse the Mnuchin trial balloon.
It did not.
In fact, in the minutes released as part of the May 2 meeting, the TBAC was vocally against launching "Ultra-longs" at this moment saying "while an ultra-long is most likely to be demanded by those with longer-dated liabilities, the Committee does not see evidence of strong or sustainable demand for maturities beyond 30-years."
The TBAC highlights the change in US TSY issuance patterns over the past three and a half decades, and notes that since 1980, the Treasury has made minimal changes to its issuance patterns: Introduced 2 new products (TIPS and FRNs); Permanently canceled 2 products (4y and 20y); Canceled and subsequently re-introduced 3 products (3y, 7y and 30y).
"The Treasury commands an issuance premium due to its regular and predictable issuance pattern: Regular and predictable means issuance happens in all interest rate environments"
The committee also notes that "Borrowers with Large Funding Programs Are Generally Less Opportunistic in
their Approach to the Market"
The TBAC further "recommended that further work be done to study these demand dynamics to get a better sense of where an ultra-long bond might price, which could be above or below the longest maturity debt issuance based on the pricing of domestic ultra-long derivatives, ultra-long bonds abroad, and theoretical models."
Instead of rushing to issuing 50 and 100-year paper, the TBAC suggested that "regular and predictable issuance policy should remain the central consideration to minimize Treasury’s funding cost over time." It also suggested other ways that Treasury might tap potential demand from long-duration investors. As such it recommended that "Treasury consider issuing a zero coupon 50-year bond, and coupon maturities between 10- and 30-years, preferably the reintroduction of the 20-year."
Furthermore, the TBAC noted that it does not expect "meaningful ultra-long supply"
And while the TBAC was pessimistic about demand for 50 Year paper, it explicitly recommended against issuing a 100-year bond due to "limited pension or insurance cash flows beyond 50-years and the preferable attributes of stripped 30-year bonds to meet a similar duration as a 100-year coupon bond."
Here is the full breakdown of TBAC recommendations on ultra-long dated paper:
After getting spooked by discussion of ultra-long dated paper in the past 24 hours, the kneejerk reaction in the 30Y to what initially appeared to be TBAC skepticism to 50 and 100 year paper, was favorable.
In a separate matter, the TBAC commented on the "potential timing and pace of the normalization process" of the Fed's balance sheet "as well as any pricing impacts on fixed income markets." This is what it said: "The Committee believes that the financing gap will likely need to be addressed by additional issuance that could begin in short-maturity coupons and bills. However, over a longer-period, it would likely be preferable to spread the increase in issuance across the curve in order to better stay below the overestimated maximum issuance sizes, according to the semi-annual survey of primary dealers."
As for its thoughts on market impact, the TBAC said that studies of the impact of large scale asset purchases "were viewed as setting an upper bound for yield increases." It added that the market expected resumption of secondary market purchases once the desired balance sheet is achieved "was also viewed as potentially mitigating the market impact."
It also had the following discussion of market impact under a higher budget deficit:
The market impact of Fed redemptions combined with the possibility of a higher budget deficit is uncertain. The dealer survey may not be sufficiently robust to capture the impact of such large changes in new issue sizes. Moreover, studies by Fed staffers and others regarding the impact of large scale asset purchases are probably not applicable to a balance sheet unwind and, at best, provide only an upper bound of the potential market impact. In fact, the likelihood that the Fed is likely to resume secondary market purchases of Treasuries once they have achieved a “normal” balance sheet (sometime in 2020 according to our estimates) could cushion the impact in the interim. It is also worth noting that these purchases will have to account for both the typical growth in Fed liabilities (currency, etc) as well as ongoing MBS redemptions.
The conclsion: "any slowdown in the pace of Treasury redemptions could ease the market impact, as it would limit the speed at which the funding would need to be replaced by marketable borrowing."
* * *
Aside from ultra-long dated bonds and the Fed's balance sheet renormalization, the TBAC also discussed the government's upcoming funding needs, "noting that the net marketable borrowing needs based on dealer estimates are higher than recent CBO estimates," as well as a brief discussion on the potential impact of a government shutdown, saying that "Treasury could have withstood a loss of market access for an average of 7 days and would have been protected against losing market access for 5 days approximately 79 percent of the time. The debt limit impasse of 2015 was noted as the predominant reason for Treasury missing its 5-day liquidity target 21 percent of the time."
* * *
The TBAC presentation on Ultra long-Dated issuance is below (link)
http://www.scribd.com/embeds/347164944/content