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5/5/2020 TBAC Report to the Secretary August 4, 2015 U.S. DEPARTMENT OF THE TREASURY Press Center TBAC Report to the Secretary August 4, 2015 8/5/2015 Le er to the Secretary Dear Mr. Secretary: Since the Commi ee last met in May, economic ac vity has accelerated substan ally. Second quarter annualized real GDP growth rebounded to 2.3% according to the advanced es mate, up from a revised and mildly posi ve 0.6% in the first quarter. Weakness in the first quarter has been primarily a ributed to transitory factors, including adverse weather and disrup ons caused by the West Coast port strike. In addi on, the strengthening of the U.S. dollar affected the manufacturing sector, while the plunge in oil prices led to a sharp decline in energy investment. As the transitory factors fade, domes c demand has strengthened no ceably over the past few months. Consumer spending accelerated and net exports and state and local government spending rebounded moderately, while fixed investment stalled. Non-na onal account indicators also point to a strengthening of the economic outlook. Household and business confidence measures remain near post-crisis highs, the housing market con nues to strengthen, wage growth has begun showing signs of gradual accelera on, and the unemployment rate has moved closer to its natural level. These changes indicate an improved economic picture, with the pace of economic ac vity running clearly above poten al. The largest contributor to GDP growth during the second quarter was private consump on which grew at a real annualized growth of 2.9% and contributed 2.0 percentage points. The rebound was en rely due to consumer spending on goods. Vehicle sales picked up from an annualized sales pace of 16.6 million in the first quarter to 17.1 million in the second quarter. Disposable income increased, benefi ng from lower gasoline prices, and the savings rate con nued to decline, although it remains considerably above pre-crisis levels. The gradual re-leveraging of consumer balance sheets, along with strong consumer confidence, should support con nued consump on growth. The housing market has generally strengthened a er a winter slowdown, but prints from various indicators remain mixed. On the posi ve side, exis ng home sales have exceeded expecta ons and reached a new post-crisis high at an annual rate of nearly 5.5 million units, pending home sales con nued to rise, and homebuilder indices reached post-crisis highs. On the weaker side, new home sales disappointed with declines in all regions except the Northeast, and home prices---although they con nue to rise---have advanced more slowly than market expecta ons. On net, recent trends point to further strengthening of the housing market. Household forma on con nues to rise, driven by renter-occupied units, and mortgage lending standards con nue to ease. Total fixed investment growth decelerated from 3.3% in real annualized terms during the first quarter to 0.8% in the second quarter. Residen al investment grew 6.6% but overall business fixed investment declined. While intellectual property investment by businesses grew at a healthy pace during the quarter, it was offset by contrac ons in structures and equipment investment, primarily in the oil and gas sector. Although overall business fixed investment remains weak, it is expected to rebound in the second half of the year. A er a sharp decline in the first quarter of the year, net exports have rebounded more recently. The bulk of the impact from U.S. dollar apprecia on was felt in the first quarter, when exports declined sharply. Since March, however, the dollar stabilized and allowed for a bounce back in annualized export growth by 5.3% in the second quarter, while imports decelerated to 3.5%. Despite that rebound, net exports are expected to decline over the next few quarters as dollar strength resumes and global demand is expected to remain weak. Labor markets have been improving. During the second quarter, 664,000 new jobs were created, and the unemployment rate fell to 5.3%, near many es mates of the natural rate of unemployment. S ll, part me and broader measures of unemployment remain elevated, and most measures of compensa on growth remain li le changed around 2%. The personal consump on expenditures (PCE) price index increased at a 2.2% annual rate during the second quarter, as energy prices par ally rebounded from their earlier declines. The ex-food and energy core PCE price index increased at a 1.8% annual rate last quarter, but is up only 1.3% over the prior four quarters. FOMC statements and communica ons from Federal Reserve officials con nue to point in an accommoda ve direc on, but at the same me, they have kept the door open for a federal funds rate increase to take place in the second half of the year. At present, market par cipants remain divided in their expecta ons for when exactly the hike will take place, but there is broad consensus that the decision will depend on the evolu on of infla on and labor market slack over the next few months. Against this economic backdrop and as part of Treasury and TBAC’s efforts to determine the op mal debt issuance strategy, the Commi ee’s first charge was to examine the meaning of “regular and predictable” in the Treasury’s stated debt issuance policy. In addi on, the Commi ee was asked to evaluate the impact of the policy on Treasury’s flexibility to adjust issuance pa erns as warranted to achieve its goal of issuing at the least cost over me to the US taxpayer and maintaining a well-func oning market. Treasury has adhered to a regular and predictable issuance framework since the 1970's when the deficit began to increase significantly and research shed light on the increased costs of a more tac cal approach. To be regular and predictable, Treasury standardized its communica ons with regard to its debt issuance schedule and expected size of auc ons, typically as part of the Quarterly Refunding announcement, and provided significant lead me regarding the introduc on or elimina on of par cular maturi es or new instruments. The Commi ee noted that the benefits of issuing in a regular and predictable framework include a projected lower borrowing cost as the Treasury captures the associated liquidity premium. In addi on, the Commi ee discussed the benefits of increased flexibility given the uncertain environment in which the Treasury operates, including the ability and willingness to adjust issuance pa erns in response to changing deficit funding needs, the Fed’s decision regarding SOMA reinvestments, market disloca ons, and changes in term or infla on premiums. Offse ng these benefits are the poten al costs of being more tac cal if investors demand a higher risk premium due to a less predictable issuance pa ern. The Commi ee discussed the parameters by which Treasury could adjust issuance pa erns including size, frequency, maturi es, and instruments. In making adjustments, Treasury should consider the impact on market func on, the depth and sustainability of investor demand, and primary dealer constraints, and should take account of longer-term funding needs and projected funding costs. The Commi ee discussed the benefits of maintaining a full yield curve with liquid benchmark securi es and emphasized the need to establish a well-planned and clear communica on strategy, while avoiding a purely formulaic approach. Given the size of issuance needs, adjustments to issuance pa erns should be gradual and should incorporate primary dealer feedback. Communica on regarding adjustments to issuance should also be as comprehensive as possible, ideally with an explana on of the ra onale and how the adjustments are in support of Treasury’s debt management principles and objec ves. The Commi ee’s second charge was to discuss the risks and benefits of increasing the propor on of longer-term debt rela ve to shorter-term debt in light of historically low interest rates and term premiums and whether doing so would be in keeping with Treasury’s mandate to fund the government at the lowest cost over me and maintain a regular and predictable debt issuance schedule. One Commi ee member prepared slides showing that interest rates and term premium are near mul -decade lows and reviewed past issuance pa erns that have increased the propor on of coupon debt rela ve to Tbills, resul ng in a lengthening of the average maturity of the debt from a low of 48 months to 70 months, the highest seen since the 1950s and well above the 59 month long-term historical average. One member noted that longer maturity debt issuance is warranted when real rates are low, term and liquidity premiums are low rela ve to those on shorter-dated securi es, correla on of interest rates with GDP growth is low or lags GDP growth and/or longer-term assets would benefit from a liability match. Simula ons of adjus ng debt issuance from the current pa ern -which is skewed toward short to intermediate maturi es- to issuance that is more evenly propor oned, shows that the cost of issuing longer-term debt is currently low but that the insurance benefits are https://www.treasury.gov/press-center/press-releases/Pages/jl0141.aspx 1/2 5/5/2020 TBAC Report to the Secretary August 4, 2015 marginal. This analysis, however, makes several important assump ons about term premiums at different maturi es and that the issuance of longer-term debt does not increase funding costs. Benefits of issuing a greater propor on of longer-term debt could be a reduc on in borrowing cost vola lity, and be er addressing the ALM mismatch with long-maturity student loan assets held by Treasury. Costs include the uncertainty of funding expense due to varying term and liquidity premiums, uncertain investor demand and the slower adjustment in interest expense to changing nominal growth rates. The member presented a simula on of short-term interest rates, no ng an ability to save interest expense based on current term premiums but that the savings may not be as large as they have been historically. The Commi ee also discussed the current liquidity premium afforded to Tbills, given the demand for high quality liquid collateral. The Commi ee noted that further analysis is warranted regarding the asset liability framework and the durability of liquidity premium in the front end of the curve. The Commi ee’s third charge was to examine whether adjustments to the Treasury’s debt issuance schedule were warranted in light of current and projected funding needs. To inform this discussion, Treasury staff provided the Commi ee with the a ached presenta on on the fiscal outlook, receipts and outlays, financing projec ons and auc on demand. Given the projected increased funding needs in FY2016 and beyond, which could increase further were the Fed to end reinvestment of Treasury maturi es, the Commi ee recommended that the Treasury maintain its current issuance pa ern. While opera onal cash balances can be adjusted via Treasury bill issuance, it was noted that both bill issuance and the Treasury’s opera onal cash balance may need to be cut drama cally over coming weeks and months if Congress does not raise the debt limit in a mely manner. As discussed in prior le ers from the Commi ee, there is poten ally significant risk associated with holding a lower opera onal cash balance and there are nega ve implica ons for bill market func oning associated with large issuance reduc ons. These risks could be exacerbated by a confluence of events related to the implica ons of money market reform and the stance of Federal Reserve monetary policy. The Commi ee also emphasized the importance of smooth market func oning to minimizing the cost of debt issuance over me and was suppor ve of increasing the stock to Tbills outstanding to aid the proper func oning of the short-term debt markets given the increasing demand for high-quality liquid collateral in light of regulatory changes. The percentage of Tbills outstanding is at a mul -decade low of approximately 11%, with an outstanding stock of $1.4 trillion. In addi on, given the low level of rates and term premium, the Commi ee was suppor ve of issuing coupon debt in similar propor ons to recent auc ons to allow for a laddered debt maturity profile and a gradual lengthening of the average maturity of the debt outstanding. Nevertheless, the Commi ee strongly encouraged Treasury to con nue to conduct rigorous cost/benefit analysis to determine its op mal debt issuance strategy based on the principles and objec ves of debt management and to communicate future issuance choices within the context of those objec ves. Respec ully, _______________________________ Dana M. Emery Chairman ________________________________ Cur s Y. Arledge Vice Chairman August 2015 TBAC Recommended Financing Table Q3 2015 https://www.treasury.gov/press-center/press-releases/Pages/jl0141.aspx and August 2015 TBAC Recommended Financing Table Q4 2015 2/2
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