Why Ultra-Long Bonds Are an Ultra-Long Shot
Treasury Secretary Steven Mnuchin wants to create 50-year and perhaps 100-year paper, but skeptics say it’s unlikely to happen.
With chances seemingly dimming for the Trump administration to pass tax reform and infrastructure spending plans, do ultra-long Treasury bonds represent its best chance for a fiscal victory before next year’s congressional elections?
Treasury secretary Steven Mnuchin seems willing to bet on it. He appears to be the driving force behind the idea to create 50-year and perhaps 100-year paper, telling Bloomberg in May that they “absolutely make sense.” Mnuchin even formed a working group at Treasury to study the concept. While market participants express opposition to the idea, a former Treasury official thinks it’s likely to happen, as the White House seeks just such a triumph.
The attraction of issuing ultra-long bonds is that it could reduce the Treasury’s borrowing costs. The thinking is that if demand is strong enough for a 50-year bond, its yield could even fall below that of 30-year bonds. That’s because of an arcane fixed-income principle known as convexity, which dictates that sometimes when interest rates fall, the yields of longer-term bonds drop further than those of shorter-term bonds. Also, sometimes when rates rise, yields of longer-term bonds appreciate less than those of shorter-term bonds.
The U.K. and Canada frequently issue 50-year debt at lower rates than 30-year debt, notes Mark Cabana, head of U.S. short rates strategy at Bank of America Merrill Lynch. But given the depth of the 30-year Treasury market in the U.S., many experts say it’s unlikely that would happen here.
“We believe that if the Treasury did it, the market would curve 10 to 40 basis points of yield above the 30-year,” says Michael Collins, senior investment officer at PGIM Fixed Income in Newark, New Jersey. What’s more, demand for 50-year Treasuries could cannibalize demand for 30-year paper, pushing 30-year yields higher and disrupting the yield curve, Cabana says. “That’s not a real cost savings.”
The Treasury Borrowing Advisory Committee (TBAC), made up of banks and money managers, expressed opposition to ultra-long Treasury issuance in the minutes of its May meeting. But Mnuchin continued to show interest in the idea in June.
Market participants object to ultra-long bonds because they see no guarantee that the paper would lower the Treasury’s debt burden and no swell of demand from investors.
“The Treasury’s objective should be issuing debt with the least expected cost to taxpayers over time, and after that to minimize disruptions to financial markets,” says Seth Carpenter, former assistant Treasury secretary for financial markets and now chief U.S. economist at UBS. Given those goals, he opposes issuing ultra-long Treasuries now.
One justification for ultra-long bonds is that the Treasury could lock in historically low interest rates. If the 3 percent economic growth the Trump administration trumpets actually comes to pass, yields could arguably rise 100 basis points across the yield curve, Collins says. “But we have a different view. Forces are driving GDP potential lower rather than higher,” he says. And if yields do rise, the Treasury will likely have to pay up to issue 50-year paper.
Furthermore, any uncertainty about investor demand for ultra-long bonds is a problem, and experts are unconvinced that investors will clamor for ultra-long Treasuries. “You don’t want to bring out something that will have to be changed,” Cabana says. “There’s a potential of orphan issues trading poorly.”
The natural investor base consists of insurance companies and pension funds, which could match ultra-long bonds to their ultra-long liabilities. But the number of pension funds is shrinking, because of the shift to defined contribution retirement plans from defined benefit plans, notes Scott Mather, chief investment officer of U.S. core fixed income at PIMCO in Newport Beach, California.
He and others say there’s no massive, unmet need for 50-year Treasuries. In its May minutes, TBAC stated: “While an ultra-long is most likely to be demanded by those with longer-dated liabilities, the committee does not see evidence of strong or sustainable demand for maturities beyond 30 years.”
There is talk linking ultra-long Treasuries to an infrastructure spending plan. But given that there is no plan to speak of yet, “it’s difficult to see the Treasury moving ahead with that in mind,” Mather says.
Given market participants’ opposition to ultra-long government paper, many of them say it’s a 50-50 proposition at best that the Treasury will issue it. But Carpenter says this view ignores the political angle. “The Treasury Department wants to show it’s shaking things up and is running government like a business,” he says.
Carpenter doesn’t see Treasury moving on the issue this year, because Mnuchin is preoccupied with a host of other issues and the department still has many open staff positions to fill.
“But once you get more people in the department beginning next year, then you have the bandwidth,” he says. “The administration won’t have had too many wins. They want to show something for the 2018 election.”