Treasury's New Approach to Debt: Go Short

By Nick Timiraos Features Dow Jones Newswires

The Treasury Department has unveiled a new strategy for managing federal debt that could ease pressures set to push up long-term interest rates and reduce a potential drag on the economy.

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Under the plan unveiled earlier this month by Treasury, the department would increase the share of shorter-term debt issuance and reduce the share of longer debt issuance, ending a yearslong trend that favored long-term debt issuance.

Total issuance of government debt will still rise in coming years with growing federal budget deficits. As that supply increases, it is likely to weigh on bond prices, pushing up yields, which rise as prices fall. And Treasury yields influence other household and business borrowing costs throughout the economy, such as on mortgages and corporate bonds.

The Treasury's new approach will shift some of that upward pressure on yields to shorter-term debt and away from longer-term debt.

The move will also help offset another source of upward pressure on long-term yields -- the Federal Reserve's slow retreat from purchasing long-term Treasurys. The central bank last month began reducing its reinvestment of the proceeds of maturing long-term government bonds into new ones. That reduction in demand, particularly coming at a time of growing supply, is likely to further weaken prices and nudge long-term yields higher.

"The impact on the market of the Fed's balance sheet runoff is entirely determined by how the Treasury refinances those missing Fed auction purchases," said Lou Crandall, chief economist at financial research firm Wrightson ICAP. "That Treasury is not going to pile on should be somewhat reassuring," he said.

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The move also coincides with Treasury Secretary Steven Mnuchin's apparent retreat from plans to issue bonds with 50- or 100-year terms -- which would have boosted the supply of long-term debt, further weighing on prices and pushing up on yields.

After President Donald Trump's election last year, Mr. Mnuchin sent long-term Treasury yields climbing when he said the U.S. should consider extending the maturity of Treasury debt, including by issuing ultralong bonds.

Mr. Mnuchin appears to have shelved those plans after Wall Street investors, including a Treasury committee with representatives of the nation's largest financial institutions, told the department it didn't see strong or sustainable demand for such debt. The longest U.S. bond now is 30 years in duration.

"Mnuchin went out hard and pressed as many people as he could to support that idea," said Jim Vogel, an interest rate strategist at FTN Financial. "I don't think anybody slammed the door in his face, but people really did hate that idea."

The Treasury plan would end a stretch in which it has issued a historically high proportion of longer-term debt. The weighted average maturity of U.S. debt has exceeded 70 months for the past year, near a multidecade high and up from a recent trough of 49 months in 2008.

The supply of Treasury government debt has been rising, with the U.S. government running deficits of 3.5% of gross domestic product for the year ended October, up from 2.6% one year earlier. Any deficits from a tax cut passed later this year or next year by Congress would further boost Treasury borrowing.

Meanwhile, the Fed will allow $6 billion in Treasury debt to mature every month during the fourth quarter without reinvestment, and that monthly amount will increase by $6 billion every quarter to a maximum of $30 billion at the end of next year.

Earlier this decade, the Treasury reduced short-term debt issuance as the supply of new debt was falling. An improving economy led to declining budget deficits. As a share of total marketable debt, Treasury debt with a maturity of less than one year has held at its lowest levels since 2000 for most of this decade.

After several years issuing a greater share of longer-term debt, the benefit of continuing to extend the average maturity "starts to diminish in terms of the gains we get," said Monique Rollins, the Treasury's acting assistant secretary for financial markets, at a Nov. 1 briefing. "We're looking at kind of a stabilization from here."

The decision to issue a growing proportion of debt with shorter maturities now has "logic to it," said Mr. Vogel. "They have been building flexibility into their debt planning for years. You could argue they're exactly at the point where they need to start using it."

Write to Nick Timiraos at nick.timiraos@wsj.com

(END) Dow Jones Newswires

November 16, 2017 05:44 ET (10:44 GMT)