Financial market implications of the federal debt pay down

Brookings Papers on Economic Activity

Volumn , Issue 2, 2000, Pages 221-249

  Fleming, Michael J ^a  

^a FEDERAL RESERVE BANK OF NEW YORK   (United States)

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EID: 0001478628     PISSN: 00072303     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Article

References (59)

1. U.S. Treasury, "Monthly Treasury Statement," September 2000.
2. Office of Management and Budget, "Mid-Session Review," June 26, 2000. Debt held by the public includes both marketable and nonmarketable securities and totaled S3.4 trillion as of July 31, 2000. It excludes debt securities held as assets by U.S. government accounts ($2.2 trillion as of July 31, 2000) but includes Federal Reserve holdings.
3. The benchmark uses of Treasury securities, the implications of the federal debt pay-down, and the viability of alternative benchmarks are also discussed in Fleming (2000a).
4. Board of Governors of the Federal Reserve, "Minutes of the Federal Open Market Committee: March 21, 2000" (www.bog.frb.fed.us/fomc/MINUTES/20000321.HTM).
5. Auerbach and Gale (2000).
6. Congressional Budget Office (2000).
7. U.S. General Accounting Office (1998) examines the implications of investing Social Security funds in the stock market.
8. For a more detailed introduction to the Treasury securities market see Dupont and Sack (1999) and Fabozzi and Fleming (2000).
9. Fleming (1997) describes the round-the-clock market, and Fleming (2000b) analyzes trading activity, bid-ask spreads, and other measures of Treasury market liquidity.
10. Federal Reserve Bank of New York (www.ny.frb.org/pihome/statistics/msytd.00). Primary dealers are firms with which the Federal Reserve Bank of New York interacts directly in the course of its open market operations. Because trading volume data are collected from all of the primary dealers but from no other entities, trades between primary dealers are counted twice, and trades between nonprimary dealers are not counted at all.
11. In a repo, a party agrees to exchange collateral for cash and, at the same time, to buy back that collateral at a specified price at some point in the future. A dealer owning a particular Treasury note, for example, might agree to sell that security to another dealer and to buy it back the next day. The first dealer can thus use the repo market to finance its positions, often at a favorable rate, and the second dealer can use the same market to borrow and then sell securities it does not hold in its portfolio. For a further introduction to repos, see Duffie ( 1996) and Jordan and Jordan ( 1997).
12. Estrella and Mishkin (1998).
13. Zero-coupon securities are created from existing Treasury notes by separating, or stripping, the coupon payments both from the principal and from one another into individual securities. The Treasury's STRIPS (Separate Trading of Registered Interest and Principal Securities) program, introduced in February 1985, facilitates stripping and reconstitution and thereby improves market liquidity. For a recent analysis of Treasury market integration, see Bennett, Garbade, and Kambhu (2000).
14. Sarah Landis, "Adjustable-Rate Mortgages Face Effect of the Elimination of One-Year Bills," Wall Street Journal, August 14, 2000. The one-year constant-maturity rate is interpolated from the daily yield curve based on market quotations obtained from the Fed. Additional detail on the series is available at www.bog.frb.fed.us/releases/H15/update/.
15. In contrast, floating-rate issues are typically marketed and priced relative to the London interbank offer rate, the short-term rate charged among banks in the Eurodollar market. An August 1999 issue of DaimlerChrysler AG, for example, had a three-year floating-rate portion marketed relative to the London interbank offer rate (LIBOR) along with five-year and ten-year fixed-rate portions marketed relative to comparable Treasuries (Gregory Zuckerman, "Under Boom Economy, Strain over Debt," Wall Street Journal, August 18, 1999, p. C1).
16. Federal Reserve Bank of New York, "Domestic Open Market Operations during 1999" (www.ny.frb.org/pihome/annual.html). These operations are termed "permanent" because they are intended to address permanent changes in the supply of or demand for balances at the Fed and because they permanently affect the size of the Fed's System Open Market Account. "Temporary" operations, in contrast, are used to address shorter-term movements in the supply of or demand for balances.
17. Federal Reserve Bank of New York, "System Open Market Account Holdings" (www.ny.frb.org/pihome/statistics/); these data exclude the effects of sales under matched sale-purchase transactions.
18. Board of Governors of the Federal Reserve, "Federal Reserve Statistical Release H.4.1, Factors Affecting Reserve Balances" (www.bog.frb.fed.us/releases/H41/). Foreign investors in the aggregate held $1.2 trillion in Treasury securities as of June 30, 2000, or 40 percent of marketable Treasury securities outstanding on that date (Treasury Bulletin, September 2000, pp. 23 and 47).
19. Board of Governors of the Federal Reserve, "Federal Reserve Statistical Release H.4.1, Factors Affecting Reserve Balances" (www.bog.frb.fed.us/releases/H41/). Foreign investors in the aggregate held $1.2 trillion in Treasury securities as of June 30, 2000, or 40 percent of marketable Treasury securities outstanding on that date (Treasury Bulletin, September 2000, pp. 23 and 47).
20. Treasury Bulletin, September 2000, p. 47.
21. Saidenberg and Strahan (1999) discuss this "buffer stock" approach to providing liquidity in their analysis of bank lending during the financial market turmoil of fall 1998.
22. Significant debt management changes are typically announced at the Treasury's quarterly refunding press conferences. The press releases for such conferences are posted at www.treas.gov/press/releases. Also see Dupont and Sack (1999), U.S. General Accounting Office (1999), and Bennett, Garbade, and Kambhu (2000) for a discussion of recent changes in Treasury debt management.
23. Issuance figures are calculated using data available at the Bureau of the Public Debt's website (www.publicdebt.treas.gov/of/ofaicqry.htmj.
24. "On-the-run" securities are the most recently issued securities of a given maturity. Older securities of a given maturity are called "off-the-run."
25. In contrast, when issuance of the five-year Treasury note was reduced from monthly to quarterly in 1998, issue sizes were increased from $11 billion to $16 billion.
26. Keane (1996) documents this pattern of repo rates over the auction cycle.
27. See Federal Reserve Bank of New York, "Announcement of Revisions to the SOMA Securities Lending Program," February 12, 1999 (www.ny.frb.org/pihome/news/announce/ 1999/soma.html).
28. See, for example, "Liquidity Angst Grows in Treasury Market," BondWeek, March 15, 1999, p. 1, and Gregory Zuckerman, "Pared Treasury Supply Poses Risks: Paying Off Debt Has a Downside," Wall Street Journal, January 27, 2000, p. C1.
29. See, for example, "Liquidity Angst Grows in Treasury Market," BondWeek, March 15, 1999, p. 1, and Gregory Zuckerman, "Pared Treasury Supply Poses Risks: Paying Off Debt Has a Downside," Wall Street Journal, January 27, 2000, p. C1.
30. The timing of the inversion on and around the days of debt management announcements suggests that economic fundamentals are not the sole explanation. Two of several articles relating the debt management changes to the inversion include William Pesek, Jr., "It's a Tale of Two Bond Markets: The 30-Year Treasury, and Everything Else," Barron 's, January 31, 2000, p. MW8, and Joshua Chaffin, "Search on to Replace the 30-Year Bond: Most Bond Traders Have Turned to the 10-Year Note as the New Market Benchmark," Financial Times, May 19, 2000, p. v.
31. The timing of the inversion on and around the days of debt management announcements suggests that economic fundamentals are not the sole explanation. Two of several articles relating the debt management changes to the inversion include William Pesek, Jr., "It's a Tale of Two Bond Markets: The 30-Year Treasury, and Everything Else," Barron 's, January 31, 2000, p. MW8, and Joshua Chaffin, "Search on to Replace the 30-Year Bond: Most Bond Traders Have Turned to the 10-Year Note as the New Market Benchmark," Financial Times, May 19, 2000, p. v.
32. Spreads between on-the-run and off-the-run securities widened significantly during the financial market turmoil of fall 1998 (Bank for International Settlements, 1999; Fleming, 2000a, 2000b) and were already wider than usual before the debt management announcements.
33. Using February 17, 2000, data, McCulloch (2000) estimates that investors are paying the Treasury a 3.09 percent annual rate to hold their principal for the year and a quarter between February 2029 and May 2030. He argues that this anomaly is not adequately explained by differences in liquidity or expected specialness.
34. The yield differential between Treasury bills and coupon securities is examined by Amihud and Mendelson (1991) and Kamara (1994).
35. The evidence from correlations is less compelling when the yield changes are measured over shorter intervals. This may reflect short-term idiosyncratic price behavior, or data measurement problems for the non-Treasury instruments, or both.
36. See for example, John M. Berry, "Treasuries' Vanishing Act; As U.S. Borrowing Shrinks, Investors Big and Small Seek Safety Elsewhere," Washington Post, July 30, 2000, p. H1, and Simon Boughey, "Casting a Long Shadow: With Fewer Treasurys and Alternative Benchmarks Uncertain, the Credit Markets Turn Chaotic," Investment Dealers' Digest, April 3, 2000, p. 16.
37. See for example, John M. Berry, "Treasuries' Vanishing Act; As U.S. Borrowing Shrinks, Investors Big and Small Seek Safety Elsewhere," Washington Post, July 30, 2000, p. H1, and Simon Boughey, "Casting a Long Shadow: With Fewer Treasurys and Alternative Benchmarks Uncertain, the Credit Markets Turn Chaotic," Investment Dealers' Digest, April 3, 2000, p. 16.
38. Gregory Zuckerman, "Quirk in Yields Is Making Bonds More Attractive," Wall Street Journal, February 2, 1999, p. C1.
39. Gregory Zuckerman and Sonoko Setaishi, "Treasury Prices Drop as Supply Concerns Ease: Vodafone Finds Demand for $5.25 Billion Issue," Wall Street Journal, February 8, 2000, p. C21.
40. Sarah Landis, "Adjustable-Rate Mortgages Face Effect of the Elimination of One-Year Bills," Wall Street Journal, August 14, 2000, quoting Michael Cloherty, a Treasury strategist at Credit Suisse First Boston Corporation.
41. For more detail on the agency debt securities market, see Fabozzi and Fleming (2000).
42. See, for example, Michael Schroeder and Gregory Zuckerman, "Treasury Official's Warning Rocks Bond Market, Challenging Fannie Mac's Goal to Be Benchmark," Wall Street Journal, March 23, 2000, p. C28, and Kathleen Day, "Greenspan Urges Review of Fannie, Freddie Subsidies," Washington Post, May 24, 2000, p. E3.
43. See, for example, Michael Schroeder and Gregory Zuckerman, "Treasury Official's Warning Rocks Bond Market, Challenging Fannie Mac's Goal to Be Benchmark," Wall Street Journal, March 23, 2000, p. C28, and Kathleen Day, "Greenspan Urges Review of Fannie, Freddie Subsidies," Washington Post, May 24, 2000, p. E3.
44. Federal Reserve Bank of New York (www.ny.frb.org/pihome/statistics/msytd.00).
45. Fannie Mae, Funding Notes, Vol. 5, June 2000, p. 3.
46. In August 1999, for example, a new issue of the Private Export Funding Corporation was marketed in terms of Fannie Mac's benchmark ten-year note (Gregory Zuckerman and John Montgomery, "Bonds Sustain Rally on Low Inflation, with Investors Expecting Low Inflation and Restraint on Rates from Fed," Wall Street Journal, August 26, 1999, p. C17).
47. The yield data are from Bloomberg, and the comparable corporate reference is Merrill Lynch's seven-to ten-year corporate Aa/AA index. The tire recalls are cited as a factor in the widening spreads in Steven Vames, "Economic Data Help Push Treasurys Ahead, But Some Worry That Market Can't Rally More," Wall Street Journal, September 1, 2000, p. C15.
48. The corporate debt figure is from the Bond Market Association, and the agency debt figure is from the September 2000 Federal Reserve Bulletin, p. A30.
49. Ford's debt figure is from its earnings report for the quarter ending March 31, 2000, and the agency debt figures are from the September 2000 Federal Reserve Bulletin, p. A30.
50. "Ford Credit Taps Demand for Big Issues with $5 Bln Global Note," Bloomberg, October 21, 1999.
51. Barbara Etzel, "Bond Market Assn. Forms Task Force to Study a Corporate Futures Contract," Investment Dealers' Digest, July 10, 2000, p. 3.
52. "Ford Reinforces Benchmark Status of GlobLS Programme," Euroweek, March 10, 2000, p. 22. In this case, an outstanding Ford GlobLS issue was used to price a new Ford GlobLS issue. Referencing another security from the same issuer is attractive when marketing a new security, because both securities are likely to be similarly affected by firm-specific as well as general credit market developments (that is, they are close substitutes).
53. Federal Reserve Bank of New York, "Foreign Exchange and Interest Rate Derivatives Market Survey: Turnover in the United States," September 29, 1998. Note that this is the average notional principal amount on which parties agreed to exchange interest payments rather than a measure of the value of securities traded.
54. See, for example, Gregory Zuckerman, "Treasurys Stumble as Some Investors Make Move to Agency Securities on Hopeful U.S. Comments," Wall Street Journal, April 12, 2000, p. C21, and Kara Scannell, "Ford Motor Credit Sells $4.5 Billion of Bonds, A Further Sign of Revival in Corporate Issuance," Wall Street Journal, June 8, 2000, p. C24.
55. See, for example, Gregory Zuckerman, "Treasurys Stumble as Some Investors Make Move to Agency Securities on Hopeful U.S. Comments," Wall Street Journal, April 12, 2000, p. C21, and Kara Scannell, "Ford Motor Credit Sells $4.5 Billion of Bonds, A Further Sign of Revival in Corporate Issuance," Wall Street Journal, June 8, 2000, p. C24.
56. Board of Governors of the Federal Reserve, "Minutes of the Federal Open Market Committee: March 21, 2000" (www.bog.frb.fed.us/fomc/MINUTES/20000321.HTM).
57. Federal Reserve Bank of New York, "Announcement of Changes in the Management of the System Open Market Account," July 5, 2000 (www.ny.frb.org/pihome/news/ announce/2000/an000705.html).
58. Federal Reserve Bank of New York, "Domestic Open Market Operations during 1999" (www.ny.frb.org/pihome/annual.htrnl).
59. Federal Reserve Bulletin, October 2000, p. A10.