Treasury is right to go long
Timothy Geithner wants to lock in low rates for the government while he can, extending the maturity of Treasury debt to 72 months from 49, a 26-year low.
It’s a smart move — if he can pull it off.
To do so, he’ll have to increase longer-term issuance by 40 percent, to $600 billion, according to FTN Financial estimates cited by Bloomberg. That could put pressure on interest rates, nipping the recovery in the bud.
It’s a risk he should take. The bigger risk is that the government continues to fund itself at the short end of the curve, requiring Treasury to roll over its obligations more frequently.
With short-term rates near zero, Treasury has drastically reduced interest costs by selling so much short-term debt. At a certain point it may have to do so in a less receptive market.
This week, Treasury plans a record $123 billion worth of issuance. A big buyer, meanwhile, is leaving the market: The Federal Reserve will exhaust its $300 billion purchase program for Treasuries once it buys another $2 billion.
Still, demand remains healthy. Monday’s 5-year, $7 billion auction of TIPS was well received. And at 3.52 percent, the current yield for the 10-year remains near historic lows.
Yet demand won’t be this strong forever.
For one, there’s demographics. As boomers age, more Treasury securities will be sold to finance retirements. The Social Security trust fund, the largest holder of U.S. government debt, will exhaust its surplus by 2016.
At that point, the fund will cash in its IOUs, forcing Treasury to borrow more. That sounds like a long way off, but those estimates assume an optimistic increase in employment and payroll taxes.
At the same time, recent Treasury data point to slowing demand for U.S. debt among foreigners (although a report from Barclays analyst Anshul Pradhan last week suggested that the data understate Chinese holdings by as much as $100 billion).
Retail investors, hedge funds and banks have stepped in to absorb much of the supply this year. But as tolerance for risky assets returns, even they might lose their appetite.
Staying at the short end of the curve also makes Ben Bernanke’s job more difficult. If inflation picks up or if an asset bubble arises, he may want to raise rates or sell securities to shrink the Fed’s balance sheet. Will he hesitate if Treasury is still flooding the market with paper?
So Geithner is right to seek balance sheet flexibility, and he should move quickly on his plan to extend the maturity of debt.
In the long run, however, what matters is getting spending under control. Confidence in the dollar will evaporate if we continue borrowing 5 to 10 percent of GDP every year.