The Committee convened in closed session at the Hay Adams Hotel at 11:30 a.m. All Committee members were present. 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. Other members of Treasury staff present were Fred Pietrangeli, Jennifer Imler, Amar Reganti, David Chung, Ernest Zhu, Brian Zakutansky, and Alfred Johnson. Federal Reserve Bank of New York members Dina Marchioni and Mark Cabana were also present.
DAS Rutherford began with a review of the fiscal situation noting that the economy posted a 2.8 percent growth rate in the fourth quarter of 2011. Rutherford presented a series of charts showing recent trends in receipts, outlays, and deficits. DAS Rutherford noted that the Administration’s new budget numbers are expected to be released in early February 2012.
Director Kim proceeded to discuss Treasury’s marketable debt portfolio. Using OMB deficit projections from the September 2011 report, “Living Within Our Means and Investing in the Future” and assuming no changes to the current issuance strategy, Treasury looks to be under financed in FY2012. With the same assumptions, Treasury would be over financed from FY2013 to FY2016. Any financing shortfalls in FY2012 are expected to be made up with increased bill issuance.
Director Kim next reviewed several debt metrics. As of December 30, the average maturity of the portfolio was approximately 62.4 months. In the chart presentation showing the projections for Treasury’s weighted average maturity, Director Kim adjusted future note and bond issuance on a pro-rata basis to match financing needs. The projections show that average maturity continues to extend.
Director Kim emphasized that the average maturity projections and the associated underlying assumptions for future issuance were hypothetical and not meant to convey future debt management policy or an average maturity target. He reiterated that Treasury will remain flexible in the conduct of debt management policy.
Director Kim then turned to demand characteristics within the primary market for Treasury securities. He noted that bid-to-cover ratios for TIPS auctions were at high levels across most maturity points. Director Kim noted that Treasury plans to gradually increase the size of TIPS issuance in 2012. This year, Treasury will issue approximately $150 billion of TIPS. The majority of the incremental new issuance will likely be at the 5- and 10-year tenors.
He also noted that bid-to-cover ratios remained at healthy levels for all Treasury securities, with particularly high demand for 4-week bills. The elevated bid-to-cover ratios in 4-week bill auctions in late December were related to the rule that bounds bill auction stop-out rates at zero. The question was asked if it made sense for Treasury to permit bids and awards at negative interest rates in marketable Treasury bill auctions. DAS Rutherford noted that there were operational issues associated with such a rule change, but that the hurdles were not insurmountable. It was the unanimous view of the committee that Treasury should modify auction regulations to permit negative rate bidding and awards in Treasury bill auctions as soon as feasible. Rutherford noted that any decision on this policy change would likely be made at the May refunding.
The Committee next turned to the question in the charge regarding Floating Rate Notes (FRNs).
Treasury continually seeks ways to minimize borrowing costs, better manage its liability profile, enhance market liquidity, and expand the investor base in Treasury securities. Market participants and the Committee have previously suggested that FRNs could help Treasury meet these objectives. Treasury asked the Committee to comment on the viability of such a product, along with the optimal maturity, reference index, reset frequency, payment period, and distribution mechanism. Treasury requested a specific recommendation for the structure of a Treasury FRN and for the Committee to help determine whether such a security would be additive to Treasury’s current mix of products.
The presenting member opened by discussing the demand backdrop for U.S. Treasuries, noting structural declines of high-quality assets over the last five years. Furthermore, regulatory changes could result in incremental Treasury demand. Additionally, money market funds may have demand for a Treasury FRN, especially if the final maturity were two years or less. The Committee member also noted that other short-end investors that are not constrained by money market fund regulations, such as securities lenders, municipalities, GSEs and corporations, would be a source of potential demand.
Turning next to the arguments in support of FRNs and the estimated benefits of Treasury issuing such securities, the presenting member revisited the case for extending the average maturity of Treasury’s debt portfolio. The Committee member stated that FRN issuance would reduce Treasury’s roll over burden. In addition, FRN issuance, in lieu of fixed-rate term issuance, would allow Treasury to avoid paying an interest rate risk premium. This product would allow the U.S. government to extend the maturity of its funding while reducing interest expense, depending on what securities would be replaced by FRN issuance.
The presenter discussed how the cost savings of FRNs would depend on the pricing spread versus the cost of maturity extension and the interest rate risk premium. The Committee member noted that the cost of maturity extension can be determined by using an asset swap spread of term Treasury debt over bills. In near-zero asymmetric rate regimes the member noted that interest rate risk premium can be approximated by observing the sum of at-the-money interest rate caplet costs for the tenor of the FRN.
Next, the presenting member discussed choices of reference indices and sample structures. The member noted that the majority of the floating rate securities issued by the GSEs are indexed to either LIBOR or the federal funds rate. The size of this market currently stands at $152 billion. Moreover, the majority of corporate FRNs are also linked to LIBOR. The presenter noted that LIBOR would be disadvantageous to Treasury as it would subject the government’s financing costs to bank funding risks.
The Committee member noted that issuance in the FRN market primarily occurred at maturities of 5-years and under. Additionally, the presenter stated that a higher reset frequency will result in shorter interest rate duration and lower price volatility. This characteristic may make the asset more attractive for stable-value buyers. The presenter went on to recommend that Treasury floor the coupons at zero.
In conclusion, the presenting member noted that the examination of alternative forms and structures of debt issuance is consistent with Treasury’s mission of financing the government at the lowest cost over time. It was suggested that Treasury begin by issuing a 2-year FRN with a floating rate index reset daily. This would appeal to both money market participants and investors looking for a stable-value asset.
An active discussion ensued. One member noted that FRNs would be a more cost effective way to extend maturity. Another member stressed the importance of this program becoming both large and liquid to appeal to a broad investor base. One member asked what distribution mechanism would best fit this issuance: an auction or a window. The discussion concluded with the Committee unanimously favoring FRN issuance, while noting that more work remains to be done to explore various structural considerations.
The meeting adjourned at 1:00 p.m.
The Committee reconvened at the Department of the Treasury at 6:00 p.m. All Committee members except Walter J. Muller and Stephen Rodosky were present. 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 January through March quarter (see attached).
The meeting adjourned at 6:30 p.m.