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Strategies & Market Trends : Currencies and the Global Capital Markets

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To: Sam who wrote (2009)	8/5/1999 11:08:00 AM
From: Henry Volquardsen	Read Replies (1) of 3536

Hi Sam, sorry I didn't respond yesterday. This potential Treasury buy back is more of a technical issue as far as how it will impact the general level of interest rates or the shape of the curve. Demand along the curve is not inelastic. If the Treasury were to become a net buyer of the long end it would provide a downward bias to the long end rates but not sufficient to invert the curve unless the market conditions themselves already called for an inversion. Other market participants would be responding to any move as well. Should the long end rates decline significantly you would see some of the non buyback long end demand shifted towards shorter maturities and you would likely see and increase in longer term corporate issuances to take advantage of the decline. An equilibrium would be reached well short of inversion. So in and of itself the buyback is not sufficient to prompt an inversion. The market conditions would need to be calling for an inversion first. The impact would be much more technical. The most important to bond geeks, such as me <g>, would be that there could be significant tightening of the on-the-run/off-the-run spread. There might be a marginal decline in general interest rates but not much more than simply paying down the debt. The important thing to remember is that this is not new buying. The Treasury could accomplish the same thing simply buy allowing old debt to mature. I've been getting a good chuckle out of some of the comments in the media. My favorite is that this will reduce interest expenditure. Only in the accounting ledgers. If the Treasury repurchases an old 8% coupon bond with 10 years remaining they will pay 114.88 for 100 face. So interest expense will decline but they will be paying a premium to retire the old bonds. Net net the cost will be the same as the original issuance costs and there will be no net saving. Interesting point is that the premium will show up as an expenditure and actually reduce the reported surplus. I like this very much. I am part of that apparently small group that opposes tax cuts and new spending increases. I very much want us to pay down the debt (just like AG keeps saying). This might be a very good way of doing it. Just have the Treasury buy back old bonds trading at a premium so until the reported surplus disappears. Your average politician won't be bright enough to figure it out <g> and would have to stop trying to figure out new goodies to buy votes with. I know it won't happen but I can dream <g>. Net net I don't think the buyback is that big a deal re overall interest rates. It really is just dressing up what is already happening and there are no new 'savings'. The market will adjust and I strongly doubt it will cause an inversion in the curve until the curve is ready to invert. That said I think it is a good idea. By focusing on larger more liquid issuances it will give them a small rate benefit. It will also be good for the professional community which needs large liquid issues. And finally it is a nice way to hide the budget surplus and encourage paying down the debt.

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