US debates new-for-old bond swap

WASHINGTON - MARCH 23: A statue of the first Secretary of the Treasury Alexander Hamilton stands in front of the U.S. Treasury Department building March 23, 2009 in Washington, DC. Treasury Secretary Timothy Geithner revealed the Obama Administration's plan today to buy $  75 to $  100 billion of toxic assest off the books of banks with existing TARP funds so they can quickly and effectively return to normal lending. (Photo by Chip Somodevilla/Getty Images)©Getty

The US Treasury has debated a sweeping overhaul of the $ 13tn government bond market, including a proposal to buy back old debt as officials focus on the health of trading in a core asset of many global investment portfolios.

The idea being discussed would involve retiring older Treasury debt, then replacing it with new benchmark securities, which are more widely traded, according to people familiar with the matter.

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The overhaul, which would be designed to improve trading conditions, has only been quietly discussed and could go nowhere as current Treasury officials are likely to leave office after November’s elections.

But the topic is now also gaining ascendancy among industry participants, while discussion of extensive debt buybacks highlights an official focus on the structure and efficiency of the Treasury market after wild price swings stunned investors in October 2014.

The US Treasury is in the midst of reviewing the structure of the market, billing it as the “most comprehensive” review in decades. Part of that review is focused on complaints from banks and investors that the ease of buying and selling Treasuries has deteriorated, reflecting poorer “liquidity” conditions.

“By buying cheap issues and funding the buybacks with issuance of rich on-the-run securities, the Treasury could enhance liquidity in these issues, while decreasing its borrowing costs,” said Prudential Fixed Income in response to the Treasury’s review.

The US Treasury sells large amounts of government debt every month with large Wall Street banks and brokerages helping underwrite the sales.

Investors value owning these fresh issues, also known as ‘’on-the-run’’ securities, because they trade more frequently. Bolstering the size of current benchmarks, with a focus said to be on the 10-year note, could improve market liquidity.

The US Treasury would then buy older, less liquid and therefore cheaper debt across the market, which could in theory then be reissued at a lower yield. In recent months, yields on older issues have risen more than those for recently sold debt, suggesting a deterioration in liquidity.

‘’Dealers would be in a better position to provide liquidity to customers looking to sell off-the-runs if there was a known buyback schedule that would allow them to unload the position,’’ said Lou Crandall, economist at Wrightson Icap.

Publicly, Treasury officials have played down liquidity concerns. Antonio Weiss, counsellor to the secretary of the US Treasury, said in testimony to the Senate Banking Committee in April that, “there is no compelling evidence of a broad deterioration in liquidity”.

In February 2015 minutes from the Treasury Borrowing Advisory Committee, a group of industry participants that discuss refunding issues with the US Treasury, it was suggested that the Treasury conduct further investigation into buybacks.

The idea is not new. Between March 2000 and April 2002 the Treasury bought back $ 67.5bn of existing securities as the financing needs of the government decreased, according to refunding documents.

In a number of refunding documents released by the Treasury since 2014, reference has been made to test procedures of small scale buy backs, to ensure that the Treasury is operationally capable of implementing such a procedure.

The US Treasury explicitly states in those documents that the tests should not be seen as a “signal of any pending policy changes”.

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