Monday, September 13, 2010

The Incredible Mismanagement of Treasury Debt

Interest rates are now at record lows. Indeed, current long-dated yields in the US and in the UK are now lower than they were during the Great Depression.

As I have been consistently advising, this is a great time to lock in long-term rates. Given the huge amount of money the Treasury has to raise, you would be a fool not to. Rates are headed higher.

Triple A rated corporations who have the ability to raise money in this market are all issuing long term debt. There is only one organization that is borrowing short-term, the Treasury itself.

Jason Desena Trennert writes:
One wonders how Treasury Secretary Timothy Geithner can sleep soundly at night with the knowledge that more than 60% of America's sovereign debt is set to mature within the next three years. To be precise, $5.2 trillion of U.S debt comes due in the next three years out of $8.3 trillion outstanding. The weighted average cost of U.S sovereign debt is an astoundingly low 1.21%, about the same as the current yield of the five-year Treasury note.
Trennert then tries to answer why the Treasury has so much of its debt in short-term paper:
There are only two plausible explanations for this precarious funding plan—one cynical, one practical.

On the cynical side, the choice to keep the average maturity short may be an attempt to keep interest expenses, and consequently the current budget deficit, as low as possible, regardless of the danger this could present for the long-term fiscal health of the country.

More practically, short-term funding may simply be a function of the fact that the marginal buyers of America's debt are growing uneasy with its profligacy. The Treasury Department announced last month that China reduced its holdings of U.S. Treasury's for the second straight month through June.
Whatever the reason, so much debt coming due so soon leaves the Treasury extremely vulnerable to any spike in interest rates.

If the Treasury had to pay the equivalent of the 10-year average of five-year government yields of 3.77%, it would incur additional interest costs of $133 billion annually. A rise in five-year yields to the 20-year average of 4.87% would increase the additional interest expense cost by 43% or an additional $190 billion annually, notes Ternnert.

Tennert is being conservative here. With the growing deficit from spending, rates could balloon way above historical averages. Eventually, double digit rates are not out of the question.

By focusing on the short-end of the yield curve, Geithner is creating a situation that could ultimately result in huge increase in interest expense cost for the Treasury. It really would make sense to borrow longer term, right now, even if it nudged Treasury rates on the long end a bit higher.

The ultimate outcome of the current structure of Treasury debt is a crisis down the road, which will force the Federal Reserve to step in and buy Treasury paper, ultimately leading to inflation which will push rates even higher. It will be a tiger by the tail situation that won't be pretty at all.

This is a major storm developing and it is very easy to see. Anyone holding long term debt should consider liquidating immediately. Rates are headed much higher, which means bonds will collapse.


  1. Wenzel, did you see Michael Pento on CNBC when he was bringing up these same situations and he was shut down by Erin Burnett for not falling in line with the CNBC propaganda of rates not going higher?

  2. I'm not sure if Geithner created the short term mess but I believe, through independent research I've been doing with another friend in the industry, that Treasury is making a concerted effort to move the ST overhang of approx $1.7T into the 7-10yr maturity range, at which point they will attempt to turn on the money jets and inflate away the majority of the real value of the debt. I believe the Fed is in on this scam and is assisting with a tight money stance.

    Now, it's another question entirely if they'll be successful or not, and either way the future implications are highly inflationary (talking money, not prices).

  3. They all rely on short term money. That's part of the problem.