A Tricky Task for Treasury
By Michael Wallace and Kim Rupert
On Oct. 29, the Treasury Dept. announced its borrowing requirements and debt-management strategy through the turn of the year. Treasury forecast fourth-quarter borrowing of $31 billion, assuming a $35 billion cash balance on Dec. 31. And it's also estimating $59 billion in borrowing for the first quarter of 2002.
Since Treasury had been expecting to pay down $36 billion in debt this quarter, the revision reflects a sharp deterioration in the economy as well as the increased funding needs stemming from the September 11 attacks. Treasury also said borrowings were $74 billion in the July through September period, compared to a forecast of $51 billion made last July.
These data are consistent with about a $20 billion to $22 billion refunding package, to be announced Wednesday, Oct. 31. The refunding announcement for the current quarter is unlikely to include changes to Treasury's strategy in terms of size, composition, issue elimination, or buybacks. A drought has stricken the revenue landscape via changes in tax policy and likely recession in the latter half of the year.
Compounded by stimulus aimed at the aftermath of September 11, this makes Treasury's planning job challenging. Yet, Standard & Poor's MMS expects that officials will put up an optimistic front on surpluses and debt paydown, despite the risks that loom from short-term financing of potentially long-term fiscal commitments -- something any credit-card debtor can attest to.
In late July, Treasury announced a $36 billion paydown for the fourth quarter, assuming a $30 billion Dec. 31 cash balance and a $55 billion cash balance for Sept. 30. For the borrowing announcement, MMS calculations show that keeping auction volumes at current levels will result in about a flat borrowing need for the quarter, while boosting the issues (mostly three- and six-month bills) to about $30 billion will create a net market borrowing total of about $25 billion to $30 billion.
While Treasury had no way of anticipating the consequences of September 11, it's clear from its subsequent operations that short-term borrowing is on the rise. MMS forecasts that the department will announce an auction of $13 billion in new five-year notes on Nov. 6 and follow up with a $7 billion auction of reopened 9-3/4-year notes on Nov. 7. It's worth noting that $6 billion in 10-year notes were recently reopened to ease the lending constraints in the repo market.
MMS expects that no issues will be eliminated and that bond buybacks will continue for the time being. These actions would be consistent with borrowing schemes implemented at the beginning of the year. Despite the dramatically different fiscal environment, MMS doubts that Treasury will want to make any drastic changes to the market's psyche just yet.
Over the past year, the yield curve has steepened significantly -- pricing in both an economic recovery and expanding fiscal commitments. The Fed's monetary easing has succeeded in driving short-term rates far below that of the 30-year bond. Should Treasury continue to concentrate its financings in the short term, yields on shorter maturities could be driven up quickly to narrow the wide gap between the 2-year note and the 30-year bond.
If temporary, such frontloading of borrowing is a clear winner. But if persistent deficit spending becomes a reality once again, Treasury will be forced to refinance debt sooner and at much higher rates -- a gamble it may be willing to take, for now.
Wallace is chief market strategist and Rupert a senior economist for Standard & Poor's Global Markets