Treasury Buyback Tests Seen as More Than Tool by Primary DealersLiz Capo McCormick and Kasia Klimasinska
Prospective Treasury Department purchases of outstanding U.S. debt from investors may be used beyond tests of information-technology systems, according to some of Wall Street’s biggest bond traders.
The Treasury said yesterday as part of its quarterly refunding announcement that while it will conduct small-scale buybacks this fiscal quarter to test systems, the transactions shouldn’t be viewed as a precursor of any policy change. The U.S. last bought bonds in April 2002 as part of a program to retire debt with high interest-rate coupons with money from the budget surpluses the federal government then enjoyed.
Treasury’s borrowing needs this quarter fell to the lowest level for the period since 2007 as a stronger economy boosts tax revenue, spurring speculation that the U.S. would consider purchases to maintain the issue size of current debt maturities sold in case revenue projections change.
“The idea of buybacks seems to be appearing left and right now,” said Stanley Sun, a New York-based strategist at Nomura Holdings Inc., one of the 22 primary dealers that bid on Treasury auctions. “Treasury is likely thinking that they want to be ready if the day comes that they need to use them so they should do some testing. But people in the market tend to think that when the Treasury or Fed tests something, it ends up happening, as was the case with the Fed’s reverse-repo program.”
In April, the Treasury Borrowing Advisory Committee recommended buybacks as an option to manage variations in the Treasuries seasonal financing needs. The committee, which represents investment funds and banks, said to reduce volatility in the coming years, the Treasury would need to purchase $90 billion in securities per quarter in fiscal 2015 and then rise to about $125 billion per quarter in 2020.
After testing the use of reverse repurchase agreements with its primary dealers and an expanded list of counterparties for over two years, the Federal Reserve in 2013 started a fixed-rate reverse repo facility which may be used as a tool for the eventual tightening of monetary policy.
“I want to be clear that this small-scale buyback operation should not be viewed by market participants as a precursor signal of any policy change regarding our buybacks,” Assistant Secretary for Financial Markets Matthew Rutherford said yesterday in Washington. “It is one of the tools we have in our tool set. We haven’t used it in a very long time. We don’t think there is any reason to use it right now. But in the future, should it need to be used, we want to make sure that it actually would work.”
The Treasury also said it will maintain the size of its two- and three-year note auctions and keep the amount of longer-term bond issuance unchanged from the previous quarter.
The U.S. will auction $27 billion in three-year notes on Aug. 12, $24 billion in 10-year notes on Aug. 13, and $16 billion in 30-year bonds on Aug. 14.
Budget deficits have been falling since 2009. The 2014 gap is projected at 2.8 percent of gross domestic product by the Congressional Budget Office. That would be down from 9.8 percent of GDP in 2009, when President Barack Obama took office.
“I am willing to take the Treasury at their word that this is just testing,” said Stephen Stanley, the Stamford, Connecticut-based chief economist at Pierpont Securities LLC. When they were last doing buybacks “people thought we were going to be eliminating the debt and the Treasury had gotten to the point where their on-the-run issues were very small and they didn’t want them to go smaller. That’s really the dynamic when you’d do buybacks.”
The Treasury bought back $67.5 billion in debt between March 2000 and April 2002. “This is really a ‘let’s test the pipes’ and make sure that that tool -- should we need it at some point in the future” works, Rutherford said at the press conference.
The concern discussed by the TBAC in April was that the volatile pattern of Treasury borrowing, usually involving an increased volume of debt during the individual income tax refund season before reversing as tax payments come in April, may leave Treasury vulnerable if it becomes unable to access markets at critical times.
“The Treasury’s testing buybacks is due to their desire to smooth out cash flows,” Michael Cloherty, head of U.S. rates strategy in New York at Royal Bank of Canada’s RBC Capital Markets, a primary dealer. “The issue is that the Treasury will have huge amounts of mid-quarter maturing securities in the coming years. They are worried that if they lose access to the markets for a day or two -- as occurred on September 11 -- having to rely on bills to fund those large outflows could be risky.”
Treasury will have $30 billion of three-year notes, $66 billion 10-year notes and $42 billion 30-year bonds, for a total of $138 billion maturing on one particular day in 2018, for example, Cloherty said.
The $365.9 billion budget shortfall from October through June compared with a $509.8 billion gap in the same period a year earlier, according to the Treasury Department.
“Since buybacks were discussed in April and the Treasury is now going to test them, it seems possible this will be used down the road,” Thomas Simons, an economist in New York at Jefferies LLC, a primary dealer, said in a telephone interview. “Given that buybacks had not been mentioned for the past decade until they were proposed last quarter by the borrowing committee as a potential tool to deal with the issue of large maturities past 2018, it seems the Treasury might see this as an option.”