FINANCING SHORT WHEN RATES ARE NEAR RECORD LOWS: I’M FROM THE GOVERNMENT AND I’M HERE TO HELP YOU.

5/2/13

The Fed said yesterday that it “may” start selling floating rate notes in the fourth quarter of this year.    Initially, this issuance is expected to cut into bill issuance, but the ultimate goal is to substitute the floating rate notes for intermediate to long term fixed rate paper.

The timing, of course, looks awful.   Why in the world would you want to effectively finance short when the ten year and thirty year treasuries are yielding 1.63% and 2.83% respectively, neither very far from all time low yields?  

The Treasury says that it is precisely because of these record low rates that it must sell floating rate notes; investors are reluctant to buy long term fixed rate paper under these conditions, so the Treasury has to broaden its investor base, to bring short duration investors into the fold, if it is to be able to finance the government’s shrinking, but still gargantuan, deficits.

A realist (Some insist on using the term “cynic” when referring to realists such as yours truly; I still don’t understand that, but I digress.) might ask with a not entirely straight face why the Treasury feels the need to broaden its investor base when it has absolutely no problem selling paper at these low yields.  It helps, the same realist might point out, when one buyer, the Fed, buys three quarters of the Treasury’s net issuance.   The Treasury might argue that it must prepare for the return of “normal” times, when the Fed gets out of the business of buying just about everything the Treasury issues.  

And just when, the realist might ask, will that time come?   Also on yesterday, the Fed gave no indication that it has any interest in stopping its $45 billion per month worth of purchases of treasury paper.  Indeed, Mr. Bernanke and his henchmen seemed to indicate that if things don’t get better on the employment/economic growth front, the Fed might even ramp up those purchases, along with its $40 billion per month purchases of mortgage backed paper.

The same realist might also suspect that the issuance of floating rate paper might have a lot more to do with politics than with finance; See my 3/4/13 piece EXTENDING TREASURY MATURITIES:  A BIGGER STRETCH THAN COMMON SENSE WOULD INDICATE.   Even at these near record low yields and this very flat yield curve, the Treasury will save a considerable number of basis points in the short run by substituting floaters for fixed rate paper, taking some pressure off the deficit for a year or so and allowing the politicians to claim credit for “saving the taxpayers’ money.”   Ultimately, the taxpayer will pay more when the Fed eschews locking in today’s low rates, but what do the politicians, and their effective employees at the Treasury, care?   The next election comes in the short term, so the short term is the only term that matters in Washington.