Ares
14th February 2011, 10:05 AM
The recently released Presentation to the Treasury Borrowing Advisory Committee (consisting of a 13-member committee of bond dealers and investors that meet quarterly with Treasury officials), which somehow managed to slip by under the radar, is a must read for anyone curious about the funding ability of the US government. A closer examination (and it is chock-full of must read observations) reveals far more conclusively than whatever today's budget myth may reveal, the US is truly in a dead-end situation, and that there is no way the Fed can now possibly step away from indefinite future debt monetization. And the stunner that nobody has yet mentioned: the US is actually considering GDP-linked bonds: the last recourse of a country about to go bankrupt.
Some of the key charts:
Cutting straight to the chase, interest expense on the US debt, which in 2010 was below $200 billion is expected to jump to $800 billion in 2020. Luckily, the Fed will own pretty much all the debt by then, meaning the shell game will be in full force, with all interest due to bondholders promptly remitted back to the Treasury. A Ponzi scheme by any other name...
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%202_0.jpg"/>
And the immediate follow up: the exponentially increasing debt target, er, ceiling:
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%20debt%20ceiling_0.jpg"/>
After average debt maturity hit a 23 year low recently, it has since jumped to the highest since 2003.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%201_0.jpg"/>
The reason for the increase in debt maturity: the fall off in Bills as a percentage of total, coupled with an increase in Nominal coupons. Of course, just like in 2008, all we need to drop the effective duration of the portfolio is to create another market crisis where everyone rushes to the safety of Bills.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%203_0.jpg"/>
For those asking for a graphic representation of the historic and projected holdings of the Supplementary Financial Program, look no further. This is the latest gimmick in delaying hitting the debt ceiling in about a month.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%204_0.jpg"/>
The only saving grace, the amount of debt maturing in 36 months has dropped to the lowest in 20 years. The lack of a surge in debt roll requirements means the charade can continue a little longer.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%205_0.jpg"/>
We will spare you reading the thousands of pages in the just released budget: this is the only chart that matters. There is no surplus projected within 10 years. In fact, after a hockeystick pick up in the next 5 years, it drops off again. Not even uber-optimistic projections see any improvement!
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%206_0.jpg"/>
And from the desperate we go to the surreal: the Treasury believes it can extract $2.4 trillion in Treasury demand from banks, pensions and insurers and Retail. Somehow we sense Jim Caron's involvement in this assumption. But wait, we thought everyone is migrating from bonds to stocks... How is this possible?
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%207_0.jpg"/>
Yet the most interesting section in the presentation begins on page 54 of the attached pdf, where Tiny Tim discusses other options for debt management, where in addition to Century bonds already noted previously on Zero Hedge, the Treasury is also considering GDP-linked bonds: the same contraption used by pre-bankruptcy Argentina.
To wit:
* Securities and Debt Management Techniques Discussed:
o Ultra-long bonds and associated strips: 40yr, 50yr, 100yr
o Bonds with embedded options
+ Callables
+ Puttables
o Money Market instruments
o Bonds for individual retail investors
o Floating rate bonds
+ Short floaters
+ CMT-style
o Other
+ GDP-linked bonds
+ A pure inflation security stripped from TIPS
o Debt management techniques: interest rate derivatives, buybacks, mini-tenders, debt exchanges
Who said financial innovation is only created by JPM's CDS desk:
* An Approach to Financial Innovation in the U.S. Treasury Market
o Identify areas of excess net product demand and unfilled investor niches
o Pricing analytics
o Limit rollover risk
o Lower interest cost volatility
o Expand investor base
o Liquidity
o Distribution Methods
o Time to develop market
o Ease of accounting and taxation mechanics for the U.S. Treasury and investors
Here is what the Treasury determined regarding "Ultra-Long" bonds (read 100 years):
Ultra-Long Bonds: Main Conclusions
* Demand. There is significant demand for high-quality, long-duration bonds from entities with long-duration liabilities such as insurance companies and pension funds.
* Strips. The arithmetic of the maturity-duration relationship (duration rises much more slowly than maturity for ordinary coupon bonds) suggests that if ultra-long bonds are issued, they be made strippable (the duration of strips rises linearly with maturity).
* Pricing. Dealers can determine where they see demand for the P-strip and then work backward to determine where to bid whole ultra-long coupon bond auctions.
* Distribution. P-strip demand will give dealers a solid basis for bidding ultra-long coupon auctions. Syndication methods have been successful in other countries and could further support the distribution process but normal reverse Dutch auction process may also be sufficient.
* Costs. Ultra-long bond yields are unlikely to be significantly higher than those in the 30yr sector, keeping issuing costs down. Spreads in the U.S. swap market and in overseas ultra-long bond markets are very tight to 30yr rates.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/ultra%20long_0.jpg"/>
And for those for whom ridiculous duration is a must (not PIMCO), fear not - there is an app for that: 100 Year STRIPS:
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/100%20year%20strips_0.jpg"/>
Remember how the Treasury and Group of 30 was planning on squeezing money markets to get fund transfer into bonds? It's coming.
Regulatory Paradox:Regulations are creating a possible niche for increased bill and callable issuance targeting money market mutual funds
* Money Market Mutual Funds (MMMFs)
o SEC 2a-7 regulations requires the MMMFs to shorten the term of their assets by bringing the weighted asset maturity to 60 days from 90 days and to maintain 30% of their assets have to mature within 7 days.
o This has increased the MMMFs demand for short-dated securities.
* Banks and others
o Basel III requires banks to lengthen their liabilities.
* The gap
o There may be room for increased bill and callable issuance to fill the emerging gap between MMMFs and issuers that will be created by new regulations.
o This gap will naturally widen (MMMFs will want more short paper and banks and others will want to lengthen liabilities) if market participants expect that we are entering a rate hike cycle.
o Puttable securities with puts exercisable every 60 days would find interest among MMMFs and offer a lower nominal initial interest rate for the U.S. Treasury.
And the kicker, on page 88 of 93: GDP-linked bonds. A/k/a the last recourse of any government facing insolvency:
GDP-Linked Bonds:Interesting but need more research to assess their potential
Premise:A GDP-linked bond pays a coupon based on a nation’s growth. For example, if trend growth is 3%, and a nation regularly borrows at 7%, a GDP-linked bond’s coupon will be 7% +/-the GDP deviation from trend growth (3% in this example).
Pros:
* Dampens the relationship between the business cycle and interest expense.
* Reduces the pro-cyclicality of government spending by decreasing coupon payments in economic contractions, and vice-versa in economic expansions.
* Allows investors to express a view on the economy’s future growth and may derive demand from equity index investors.
Cons:
* Complicated structure, difficult to price. Premium may be required due to volatility of cash flows.
* Debate as to whether to adjust to the rate of growth of GDP, or the level of GDP.
* Economic data, which is the basis of the reference rate, is frequently revised.
* If GDP is strong, and coupons increase, investors may be concerned that the sovereign will “call” the bond or enact buybacks.
* Demand for GDP-linked structures is unknown, extremely limited comparisons are available.
In other words: you know GDP-linkers are coming. And just in case they aren't, where are those who believe the Fed will be able to step away from monetizing the debt? We now know that there will be roughly $4.2 trillion in gross debt issuance in the next two years. Sorry, but there is no organic demand for this debt at any yields even remotely close to prevailing ones. And should interest rates go up, there goes the recovery.
Good night.
Full must read presentation (http://www.treasury.gov/press-center/press-releases/Documents/TBAC%20Discussion%20Charts%20Merged%202.2011.pdf)
http://www.zerohedge.com/article/charting-us-treasurys-toxic-debt-spiral-and-get-ready-gdp-linked-bonds
Some of the key charts:
Cutting straight to the chase, interest expense on the US debt, which in 2010 was below $200 billion is expected to jump to $800 billion in 2020. Luckily, the Fed will own pretty much all the debt by then, meaning the shell game will be in full force, with all interest due to bondholders promptly remitted back to the Treasury. A Ponzi scheme by any other name...
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%202_0.jpg"/>
And the immediate follow up: the exponentially increasing debt target, er, ceiling:
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%20debt%20ceiling_0.jpg"/>
After average debt maturity hit a 23 year low recently, it has since jumped to the highest since 2003.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%201_0.jpg"/>
The reason for the increase in debt maturity: the fall off in Bills as a percentage of total, coupled with an increase in Nominal coupons. Of course, just like in 2008, all we need to drop the effective duration of the portfolio is to create another market crisis where everyone rushes to the safety of Bills.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%203_0.jpg"/>
For those asking for a graphic representation of the historic and projected holdings of the Supplementary Financial Program, look no further. This is the latest gimmick in delaying hitting the debt ceiling in about a month.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%204_0.jpg"/>
The only saving grace, the amount of debt maturing in 36 months has dropped to the lowest in 20 years. The lack of a surge in debt roll requirements means the charade can continue a little longer.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%205_0.jpg"/>
We will spare you reading the thousands of pages in the just released budget: this is the only chart that matters. There is no surplus projected within 10 years. In fact, after a hockeystick pick up in the next 5 years, it drops off again. Not even uber-optimistic projections see any improvement!
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%206_0.jpg"/>
And from the desperate we go to the surreal: the Treasury believes it can extract $2.4 trillion in Treasury demand from banks, pensions and insurers and Retail. Somehow we sense Jim Caron's involvement in this assumption. But wait, we thought everyone is migrating from bonds to stocks... How is this possible?
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/Treasury%207_0.jpg"/>
Yet the most interesting section in the presentation begins on page 54 of the attached pdf, where Tiny Tim discusses other options for debt management, where in addition to Century bonds already noted previously on Zero Hedge, the Treasury is also considering GDP-linked bonds: the same contraption used by pre-bankruptcy Argentina.
To wit:
* Securities and Debt Management Techniques Discussed:
o Ultra-long bonds and associated strips: 40yr, 50yr, 100yr
o Bonds with embedded options
+ Callables
+ Puttables
o Money Market instruments
o Bonds for individual retail investors
o Floating rate bonds
+ Short floaters
+ CMT-style
o Other
+ GDP-linked bonds
+ A pure inflation security stripped from TIPS
o Debt management techniques: interest rate derivatives, buybacks, mini-tenders, debt exchanges
Who said financial innovation is only created by JPM's CDS desk:
* An Approach to Financial Innovation in the U.S. Treasury Market
o Identify areas of excess net product demand and unfilled investor niches
o Pricing analytics
o Limit rollover risk
o Lower interest cost volatility
o Expand investor base
o Liquidity
o Distribution Methods
o Time to develop market
o Ease of accounting and taxation mechanics for the U.S. Treasury and investors
Here is what the Treasury determined regarding "Ultra-Long" bonds (read 100 years):
Ultra-Long Bonds: Main Conclusions
* Demand. There is significant demand for high-quality, long-duration bonds from entities with long-duration liabilities such as insurance companies and pension funds.
* Strips. The arithmetic of the maturity-duration relationship (duration rises much more slowly than maturity for ordinary coupon bonds) suggests that if ultra-long bonds are issued, they be made strippable (the duration of strips rises linearly with maturity).
* Pricing. Dealers can determine where they see demand for the P-strip and then work backward to determine where to bid whole ultra-long coupon bond auctions.
* Distribution. P-strip demand will give dealers a solid basis for bidding ultra-long coupon auctions. Syndication methods have been successful in other countries and could further support the distribution process but normal reverse Dutch auction process may also be sufficient.
* Costs. Ultra-long bond yields are unlikely to be significantly higher than those in the 30yr sector, keeping issuing costs down. Spreads in the U.S. swap market and in overseas ultra-long bond markets are very tight to 30yr rates.
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/ultra%20long_0.jpg"/>
And for those for whom ridiculous duration is a must (not PIMCO), fear not - there is an app for that: 100 Year STRIPS:
<img src="http://www.zerohedge.com/sites/default/files/images/user5/imageroot/von%20havenstein/100%20year%20strips_0.jpg"/>
Remember how the Treasury and Group of 30 was planning on squeezing money markets to get fund transfer into bonds? It's coming.
Regulatory Paradox:Regulations are creating a possible niche for increased bill and callable issuance targeting money market mutual funds
* Money Market Mutual Funds (MMMFs)
o SEC 2a-7 regulations requires the MMMFs to shorten the term of their assets by bringing the weighted asset maturity to 60 days from 90 days and to maintain 30% of their assets have to mature within 7 days.
o This has increased the MMMFs demand for short-dated securities.
* Banks and others
o Basel III requires banks to lengthen their liabilities.
* The gap
o There may be room for increased bill and callable issuance to fill the emerging gap between MMMFs and issuers that will be created by new regulations.
o This gap will naturally widen (MMMFs will want more short paper and banks and others will want to lengthen liabilities) if market participants expect that we are entering a rate hike cycle.
o Puttable securities with puts exercisable every 60 days would find interest among MMMFs and offer a lower nominal initial interest rate for the U.S. Treasury.
And the kicker, on page 88 of 93: GDP-linked bonds. A/k/a the last recourse of any government facing insolvency:
GDP-Linked Bonds:Interesting but need more research to assess their potential
Premise:A GDP-linked bond pays a coupon based on a nation’s growth. For example, if trend growth is 3%, and a nation regularly borrows at 7%, a GDP-linked bond’s coupon will be 7% +/-the GDP deviation from trend growth (3% in this example).
Pros:
* Dampens the relationship between the business cycle and interest expense.
* Reduces the pro-cyclicality of government spending by decreasing coupon payments in economic contractions, and vice-versa in economic expansions.
* Allows investors to express a view on the economy’s future growth and may derive demand from equity index investors.
Cons:
* Complicated structure, difficult to price. Premium may be required due to volatility of cash flows.
* Debate as to whether to adjust to the rate of growth of GDP, or the level of GDP.
* Economic data, which is the basis of the reference rate, is frequently revised.
* If GDP is strong, and coupons increase, investors may be concerned that the sovereign will “call” the bond or enact buybacks.
* Demand for GDP-linked structures is unknown, extremely limited comparisons are available.
In other words: you know GDP-linkers are coming. And just in case they aren't, where are those who believe the Fed will be able to step away from monetizing the debt? We now know that there will be roughly $4.2 trillion in gross debt issuance in the next two years. Sorry, but there is no organic demand for this debt at any yields even remotely close to prevailing ones. And should interest rates go up, there goes the recovery.
Good night.
Full must read presentation (http://www.treasury.gov/press-center/press-releases/Documents/TBAC%20Discussion%20Charts%20Merged%202.2011.pdf)
http://www.zerohedge.com/article/charting-us-treasurys-toxic-debt-spiral-and-get-ready-gdp-linked-bonds