When Janet Yellen was confirmed as US Treasury Secretary in January 2021, questions inevitably resurfaced as to whether the Treasury should begin issuing a 50-year or even a 100-year ultralong note.
Just a few years ago, the Treasury’s debt managers, in consultation with the Treasury Borrowing Advisory Committee (TBAC), reviewed the potential issuance and concluded that it would not meet the Office of Debt Management (ODM)’s mandate of financing the government at the lowest possible cost of debt. Moreover, an ultralong note would present a challenge to the Treasury’s goal of “regular and predictable” issuance.
My purpose here is not to advocate for or against ultralong issuance, but rather to address whether the issuance framework should be updated to reflect the role of Treasuries in the modern financial system. The ultralong bond debate is an example of the inherent tension between the “lowest-cost” issuance mandate and the need for innovation and improvements to the Treasury market.
The nature of the ultralong debate
Proponents of the ultralong note argue that it would enable the Treasury to increase the weighted-average maturity (WAM) of its portfolio, potentially lock in low borrowing costs, and diminish rollover risk. Under the current framework, these are problematic arguments.
- First, it is unlikely that the Treasury could issue enough ultralong debt to substantially shift its WAM without disrupting financial markets. While the Treasury and the TBAC have constructed a WAM framework, given the sprawling nature of the Treasury’s markets, there are significant challenges to its implementation and usage.
- Short-dated bond issuance on an ex-post basis has historically met the ODM’s criteria for lowest-cost issuance under most scenarios, particularly during periods of upward-sloping yield curves.
- The Treasury has remained concerned about rollover risk, but primarily from an operational, climate-risk, and cyber-risk perspective. Beyond those issues, lack of demand for short-dated Treasuries is unlikely to lead to much rollover risk.
Events during 2019 demonstrated that when the Treasury’s front-end markets experience volatility, they invariably disrupt the US Federal Reserve’s (Fed’s) framework for monetary policy implementation (particularly the Fed Funds market), almost forcing the Fed into Treasury asset purchases on the short end of the curve. Treasury bills are also nearly perfect substitutes for reserves, leading to fewer disruptions in capital markets. This makes a strong historical and operational case that the Treasury should be doing the bulk of its net new issuance via shorter-maturity securities.
However, there are plenty of reasons for the Treasury to issue ultralong debt; they just have little to do with the lowest-cost mandate and a WAM framework. Notably, an ultralong Treasury may create positive externalities as another benchmark for private US-dollar (USD) issuance. By adding an ultralong point on the Treasury curve (beyond the 30-year note), private-sector ultralong issuance could grow over time due to improved price discovery, hedging, and benchmarking. On balance, this would be a tailwind to help enhance the breadth and dynamism of USD fixed income markets.
The market microstructure
Debt managers are often forced to think about the “caring and feeding” of the market microstructure that has built up around the rest of the Treasury curve. The widespread use of Treasuries for collateral, regulatory, benchmarking, liability-matching, and duration-management purposes is much of what makes Treasuries so attractive to such a variety of market participants. This versatility broadens, deepens, and strengthens US capital markets. The dominance of Treasuries in nearly every facet of global market operations renders it impossible to separate them from the USD’s status as a reserve currency.
But in the near and intermediate term, maintaining the financial stability of the microstructure and innovating to improve it are at odds with the mandate of lowest-cost issuance. This highlights the conflict between that mandate and an issuance strategy that will improve Treasury markets in the long term (including the benefits to USD fixed income markets and their associated functioning). Resolving this conflict and expanding the mandate beyond “lowest cost” is not the remit of the Treasury’s talented domestic finance civil servants. It would need to be resolved by appointed government officials.
Final thoughts on US debt management
I believe the next evolution of debt management should go beyond the narrow and parochial view of “lowest cost” to incorporate market microstructure, financial stability, and the USD’s reserve-currency status. However, the Treasury has not had a Senate-confirmed undersecretary for domestic finance since 2014, which has created a longer-term stasis around this critical issue. As the pandemic recedes and economic recovery kicks in, the Treasury should begin thinking beyond “lowest cost.”