The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
5/5/2020 August 2014 Quarterly Refunding Report to the Secretary of Treasury U.S. DEPARTMENT OF THE TREASURY Press Center August 2014 Quarterly Refunding Report to the Secretary of Treasury 8/6/2014 August 5, 2014 Le er to the Secretary Dear Mr. Secretary: Since the Commi ee last met in April, economic growth has rebounded following the surprisingly sharp decline in ac vity earlier in the year. Real GDP snapped back to a 4.0% annualized pace of expansion in the second quarter, a er contrac ng at a 2.1% rate in the first quarter. Growth in the second quarter benefited from the fading of several unusual one- me drags that restrained ac vity in the first quarter. While growth was also recently supported by a notable accelera on in inventory accumula on, real final sales expanded at a 2.3% annual rate in the second quarter, somewhat stronger than the 1.8% average annualized pace experienced over the course of the expansion thus far. Labor markets have con nued to improve and job growth has averaged 230,000 per month in the first seven months of the year. Geopoli cal developments remain a source of worry, but most observers expect only limited impact on the US economy. Early July data and surveys indicate that growth momentum remained solid heading into the third quarter, and private and official sector forecasters con nue to expect above-trend growth in the second half of the year. Real consumer spending advanced at a 2.5% annual rate last quarter, supported by a weather-related bounce-back in spending on autos and other durable goods. A er an unusual dip in the first quarter, healthcare spending resumed posi ve growth in the second quarter, albeit at a rela vely subdued 0.7% rate. The aggregate household balance sheet appears healthy, and labor income has shown some signs of accelera ng in 2014, which should support more sustainable gains in consump on outlays. The housing market has shown signs of recovering from the slowdown in ac vity that followed last year’s increase in mortgage rates. Exis ng home sales increased each month in the second quarter and are up 9.8% from their March lows. Nonetheless, the recovery has been uneven, as the latest new home sales, pending home sales, and housing starts reports all registered declines. Most measures of home price apprecia on have exhibited modera ng price gains in recent months. House prices had been rising at a double-digit pace, so some cooling is to be expected. Business investment spending advanced at a 5.5% annual pace last quarter, following a more-modest 1.6% rate in the first quarter. Real outlays for capital equipment increased 7.0% in the second quarter; spending on tech equipment rebounded at a 21.4% rate, following declines in the prior two quarters. The most recent orders and shipments data for capital goods were mildly disappoin ng, but most business surveys indicate con nued modest growth in capital outlays. Real government spending increased at a 1.6% annual rate last quarter. Although federal government spending contracted slightly, state and local outlays increased at a 3.1% pace, the fastest in five years. Employment in the government sector has likewise begun to improve, as total government employment has increased by 68,000 since the beginning of the year. The con nued waning of fiscal austerity remains an important reason for op mism about broader economic growth prospects. Real exports have been vola le in the first half, contrac ng at a 9.2% pace in the first quarter and expanding at a 9.5% rate in the second. The export growth last quarter was more than offset by a strong 11.7% rate of growth of real imports. Overall, net foreign trade subtracted 0.6% from GDP growth last quarter. Recent economic readings from the eurozone and Japan have been somewhat disappoin ng, while Chinese growth looks to have firmed some lately. Labor market indicators remain favorable. Job growth has averaged 245,000 per month over the past three months, and the unemployment rate has declined to 6.2%, down from 6.7% at the me of the last mee ng. Broader measures of labor resource slack have also shown improvement in recent months. The U-6 measure of labor market underu liza on – which includes marginally a ached workers and those working part me for economic reasons – has fallen 0.9% since the end of last year. Levels of wage infla on remain low, with only faint hints of an accelera on. The Employment Cost Index increased 0.7% last quarter – firm by the standards of recent years – but that came on the heels of a very so 0.3% increase the prior quarter. Average hourly earnings have increased 2.0% in the year ending in July, li le changed from the pace seen over the past four years. When the Commi ee last met in April, the most recent reading of the deflator for personal consump on expenditures (PCE) had increased only 0.9% over the prior twelve months. In the twelve months ending in June, the PCE deflator had accelerated to 1.6%. Much of that accelera on was due to rising food and energy prices. However, the core PCE index has also firmed, rising to 1.5% on a twelvemonth basis, up from 1.1% at the me of the last mee ng. As the economy makes progress toward full employment, a return to 2% infla on is a reasonable expecta on, though the rapid pick-up in core infla on in the second quarter likely reflected some one- me factors which may fade in coming months. The Fed has con nued to dial back the pace of asset purchases by $10 billion a month at each mee ng so far this year, and is on pace to complete the current purchase program at the October mee ng. The most recent FOMC statement indicates a sense of reduced downside infla on risk, but also a shi from focusing on unemployment toward incorpora ng broader measures of labor market underu liza on. Markets generally an cipate a first ghtening some me in the middle quarters of next year, and the market’s an cipated path of policy ghtening is somewhat shallower than the one expected in the central tendency of the FOMC’s interest rate forecasts. This economic backdrop as well as Treasury’s presenta on to TBAC on fiscal outlook, financing projec ons and auc on demand informed the ensuing discussions. Before addressing the formal charge ques ons, the Commi ee and Treasury staff con nued a discussion that began at the April 30, 2014 TBAC mee ng. At that mee ng, the Commi ee asked the Treasury to provide a framework to determine the prudent level of structural cash that the Treasury should maintain to minimize opera onal or technical default risk in the event of a market shutdown, where normal access to funding is disrupted or delayed. The Treasury staff reviewed the a ached presenta on en tled “Considera ons for Developing the Op mal Treasury Cash Balance,” which described Treasury’s historical approach to cash balances, risks to that approach, a framework for determining the magnitude of the market shor all were the Treasury to lose market access for a period of me, and a methodology for quan fying the appropriate level of structural cash to minimize shor all risk. A er significant discussion, the Commi ee recommended that the Treasury increase structural cash to address peak poten al shor alls in funding and believes that this would result in a posi ve net economic benefit to Treasury. More specifically, a er reviewing past theore cal shor alls over various me periods of market or opera onal disrup on, the Commi ee recommended that the Treasury should increase cash to address peak poten al shor alls over a 10 day period, approximately $500 billon in the current environment. The Commi ee asked that the Treasury provide a more detailed presenta on at a future TBAC mee ng in order to further the steps toward poten al implementa on. Following that discussion, the Commi ee’s first charge was to examine whether adjustments to the debt issuance schedule were warranted in light of current funding needs. To inform the discussion, the Commi ee reviewed the a ached debt financing outlook slides. In keeping with the Commi ee’s recommenda on from the April 2014 mee ng, the Treasury ini ated a series of 2-year and 3-year Treasury auc on size reduc ons beginning with the May 2014 refunding. The 2-year was reduced by $1 billion per month from $32 billion in April 2014 to $29 billion in July 2014. The 3-year Treasury auc on size was reduced by $1 billion per month from $30 billion in April 2014 to $27 billion in July 2014. While the Treasury forecasts overfunding through 2015, even if it con nues to reduce 2 and 3year auc on sizes, the Commi ee recommended that the Treasury maintain the auc on sizes at the July 2014 levels in order to build structural cash. Also discussed was the fact that Treasury faces an extended funding shor all beginning in FY 2016. Full considera on was given to the March 2015 debt ceiling requirement to reduce Treasury cash to $33 billion, but the Commi ee believes that this https://www.treasury.gov/press-center/press-releases/Pages/jl2602.aspx 1/2 5/5/2020 August 2014 Quarterly Refunding Report to the Secretary of Treasury obliga on can be addressed through adjustments to Treasury bill issuance. These recommenda ons are consistent with the Treasury’s prior commitment to con nue extending the Weighted Average Maturity of the outstanding marketable debt. The Commi ee’s second charge was to provide the Treasury with its views on the factors that contributed to the recent decline in asset price vola lity and forward looking measures of market uncertainty across a range of fixed income, equity and foreign exchange markets, both in the US and globally. One member presented the a ached slides to address this charge, sta ng that the primary contributor to lower vola lity over the past two years has been Fed and ECB policy. In QE1, the Fed significantly clipped downside risks in terms of economic and market outcomes. As rates approached the zero bound, vola lity was lower by construc on and contributed to maturity extensions, lower term premia and declining vola lity across other asset classes through a lower and more certain discount rate. In addi on, a more stable economic growth environment has contributed to lower dispersion of GDP growth forecasts, and enhanced forward guidance by the Fed regarding monetary policy has led to greater investor percep on of certainty regarding outcomes and an increased willingness to assume risk across a wide variety of asset classes. In addi on, given autocorrela on, low vola lity can perpetuate: low realized vola lity, normal for this phase of the economic cycle, leads to lower implied vola lity in a self-reinforcing loop. The member also pointed to various market measures, including op on pricing across asset classes, to show that expecta ons for increased vola lity are generally low. The presen ng member highlighted the poten al for excessive risk taking in periods of low vola lity as market par cipants can become complacent about future risks. The member pointed to evidence of possible increased risk taking which included recent growth in hedge fund assets and an expansion of return expecta ons rela ve to market interest rates by public pension funds, driving return-seeking alloca ons to alterna ve strategies with imbedded leverage and increased credit risk. A fla ening of vola lity term structures, currently steep versus history for certain assets classes, could suggest excessive complacency and bears watching. Concerns were also raised regarding changes in market structure resul ng from increased regula on which has reduced the liquidity available to market par cipants. This dynamic could become exacerbated in periods of increased vola lity and market disrup on, especially within the less liquid markets such as credit, emerging markets and leveraged loans. The Commi ee ended by discussing possible future mee ng topics including the pros and cons of making coupon and principal payments in the strips market fungible and issuing Treasury debt securi es with maturi es greater than 30 years. In addi on, several members suggested that the Commi ee revisit the funding strategy for the growing government student loan volumes. Respec ully, ________________________ Dana M. Emery Chairman ________________________ Cur s Arledge Vice Chairman TBAC Recommended Financing Table Q3 2014 and TBAC Recommended Financing Table Q4 2014 https://www.treasury.gov/press-center/press-releases/Pages/jl2602.aspx 2/2
@FedFRASER