Big Hitter the Lama…LONG

An omen that the long dirge of low volatility may be ending is the recent interest of the general public in the mundane operations of Treasury Dept. issuance decisions.  Larry Kudlow began floating the balloon in December and Sec Mnuchin gave the meme a boost by saying, "Treasury was looking into the concept." (Spoiler Alert- TBAC has been "looking into" it for years) The pedestrian argument for issuing 50 and/or 100 year bonds will be played by Dorothy's favorite walking companion thusly:

Rates are low, the duration of government issuance is barely over 5 years, "lock in" low rates now. Oh, and asset/liability maturity matching, but we are losing you, so, the first things.

Here's my longstanding argument for devoting time to more important issues:

The shorter duration of the T pool helps grease the gearing of the financial system through its REFUNDING. The key characteristics to refunding are that the secondary market for the issues is DEEP, WIDE and RESILIENT (the decline in this 3rd characteristic to be picked up later).

To promulgate the vitality of the process, Treasury MANDATES that the issuance schedule will be "regular and predictable". When the duration of the pool began to slide toward 4 years, the IR risk was deemed substantial enough that extending duration became a stated, incremental goal of the department. Then, this little hiccup called the complete meltdown of the financial system scared the bejeezus out of everyone and T-Bills were deemed in short supply. The Fed (the guys that get all the attention) then embarked on a once taboo activity for CBs of buying Yucca Mountain amounts of Ts and such also in "regular and predictable" arrangements and doing a little number called Twist. To avoid getting looked at like a sick patient with his hospital gown open, Treasury back burner-ed the duration extension concept. Translation: The Treasury wisely opted to not appear a TACTICAL issuer, a stigma with possible negative signaling to markets.

Kudlow likes to drop this nugget in his pitch for 50s or Centuries, "Ts held by the public have grown from 32% in 2008 to 74% in 2016." I'm yet to figure out what that means except that it would behoove the Gov. to inflate away those debts more rapidly -if it could, it's harder than textbooks would have you believe -since the holders are increasingly it own citizens, but wait, I heard China might own a fair amount of these babies too ! Let's scrap that idea ! FI practitioners (of which I once was and am considering again) compute a thing we call DV01 - dollar value of a 1 bp change in yield. The beauty in the Eurodollar contract was/is the $1million dollar size (if invented today I bet it would be 5 or 10m) and the constant "always and everywhere" $25.00 DV01. (Think of back month Eurodollars -colored Gyros in Dog-speak- as strings of zero coupons) The DV01 of $1million in 50 year bonds, let alone Century, is roughly a messy couple thousand ! The CME Group would come up with a "Super -Ultra " contract to help the hedging but the development would be hindered by the original mandate issues. And here's the problem that relates back to the RESILIENT characteristic - very few people/institutions remain in the business of making markets and gearing these securities. In fact, if the public knew the small cartel of extremely large players inter-acting with themselves, they would become uncomfortable. The Taper Tantrum and 2014 "Melt-Up" were glaring examples of fissures in the most important debt market in the world.

Here's my advice to Mnuchin and the Trump administration: Concentrate on something more important, like a regulatory environment that promotes more participation in the process.

 

One thought on “Big Hitter the Lama…LONG

  1. mike

    Excellent points in a very good commentary. While I understand the need and necessity of a “functioning” bond market I also am seeing first hand the incompetence of govt. spending and the creation of huge unfunded liabilities.

    I can cite areas that are clear needs (infrastructure etc.) and can cite bills that ain’t gonna get paid (pensions etc.) and how does that get better if interest payments take up larger and larger percentages of budgets if interest rates “normalize” (even if that is years off). Debt never is a problem until it is and while I’m not in the yelling fire in the theater crowd, seeing that we racked up record deficits in a time of record tax receipts, figuring out how to lessen the impact of rising interest rates on budgets would seem to be a good idea.

    Reply

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