Auction-Delay Decision Went Down to Wire Amid Debt-Limit Impasseby and
U.S. Treasury made call morning of Oct. 22 announcement
Episode shows pressure on debt managers during Congress debate
On Oct. 21, U.S. Treasury debt managers were huddling on conference calls late into the evening. The next morning, as has been standard practice for 40 years, the department was to announce its monthly auction of government notes, part of the reliable, predictable machinery that’s made Treasuries the world’s deepest and most-liquid bond market.
The problem was that Congress’s refusal to raise the nation’s debt limit meant this wasn’t a typical month. For weeks, Seth Carpenter, acting assistant secretary for financial markets, knew that unless circumstances unexpectedly improved, the Treasury would have to postpone one of three sales being announced, or it might breach the $18.1 trillion ceiling.
Carpenter talked with his debt-management team and checked with officials handling fiscal projections. But by 8 a.m. on Oct. 22 it became clear there was no choice other than to delay the Oct. 27 auction of two-year notes. One hour later, the news hit markets worldwide, spurring one investor to label the political bickering that triggered the decision a “debacle.” It was the first auction delay related to the debt ceiling since 2004.
“It just came down to the wire,” Carpenter said in a phone interview. “Nobody who’s trading these securities was happy about it, because it’s just another disruption.”
The Treasury had already cut the size of the sale of the popular four-week bills to the bare-bones minimum of $5 billion in mid-October. The department, whose financial-markets office Carpenter has been running on an acting basis since early this year while his nomination is pending in the Senate, also had to delay by a half hour the announcement of the results of one sale on Oct. 14, taking extra time to ensure rules weren’t violated due to the offering’s unusually small size.
“It just can’t possibly do good things to the market,” Carpenter, a former Federal Reserve official, recalls thinking as he decided to push the sale back. Yields on the notes declined following the announcement, as traders braced for the reduced supply.
Responsible for $12.8 trillion in marketable securities, U.S. debt managers seek to be as predictable as possible so investors can plan accordingly and feel comfortable trading in the securities. An unexpected delay doesn’t help meet those goals. Standard & Poor’s downgraded America’s AAA credit rating for the first time in 2011, on the heels of another debate over raising the debt limit.
Lawmakers resolved the debt-ceiling deadlock just days before Nov. 3, the date Treasury Secretary Jacob J. Lew had said the government would exhaust ways to stay under the borrowing cap. President Barack Obama signed the the bill suspending the debt limit on Nov. 2, allowing the delayed two-year note auction to take place on Nov. 4.
That sale, occurring the day Federal Reserve Chair Janet Yellen signaled an interest-rate increase was likely next month, drew the weakest demand for the issue since 2010. Yields jumped to the highest since 2011, resulting in higher costs to taxpayers.
“What they have said for decades and decades -- not only just this past year -- is that they want to let the market know exactly what they are doing,” said Ron Desautels, portfolio manager in Springfield, Massachusetts, at Babson Capital Management LLC, the investment firm owned by Massachusetts Mutual Life Insurance Co. “They don’t like to unsettle the markets.”
The changes to the supply of four-week bills came with a cost. After cutting the sale to $5 billion from $40 billion over two months, Treasury multiplied it 10-fold to $50 billion on Nov. 3, causing yields to jump to 0.07 percent from 0.01 percent a week earlier.
The Treasury was running low on the cash reserves it typically piles up as a cushion in case a hurricane or hacker attack cuts its access to financial markets.
It may be a while before the department builds those balances back to more than $150 billion, a level it considers a safe minimum. Yet increasing auction sizes could be risky. Primary dealers surveyed by the Treasury on Oct. 16 said the government can’t exceed more than $51 billion of four-week bills in a single auction without causing significant changes in yields. This makes the Treasury reluctant to go above $50 billion.
“We feel we were pretty aggressive going from $5 billion to $50 billion,” said Carpenter, who was first nominated for the Treasury post last year. “But if we maintain bill issuance at a high level for a few weeks, we will hopefully see cash come back up pretty rapidly, and then we can maintain prudent levels.”