Gyroscopic Investing

CNBC is reporting the treasury is considering issuing floating rate securities. They appear to be a 3 year maturity.

I can't imagine the Treasury issuing securities "for the good of people" so these must be cheaper to issue, at least in their calculations.

I believe that these treasuries will have their yield changed on some regular basis, depending on the current market conditions of the time, and then at the 3 year mark, mature and pay back what their face value is.

These securities don't exist yet, and it's just something the treasury is considering doing, but let's have an academic discussion about them and their possible role within the PP.

There is risk associated with buying a 3 year treasury note because if interest rates rise, the note loses money. Thus, the return on those notes is higher than shorter-duration notes/bills to compensate the investor for taking on that risk. If we remove that risk, then the yield will be lower. Even though these are 3 year notes, they will have the yield of a 30-day or 6-month security, depending on how frequently the coupon changes.

The downside, is unlike a 30-day or 6-month security, if you need to liquidate your position, you have to wait longer for the security to mature. In practice that shouldn't be a problem because there's substantial liquidity so selling a 3-year note early is no problem. In "paranoia-land" there is a slight risk with using these over shorter-term securities; the risk may be 0.01% but it's there, and it's quantifiable, if even at a low level.

It seems like the benefits are reduced transactional overhead. If your portfolio calls for 6-month securities, rotated out every 6 months, (as in the cash portion of the PP), then buying a 3-year note with 6-month yield change should give you an equivalent result, with reduced overhead of buying securities.

Similarly, the treasury realizes similar overhead reduction. They can pay the reduced rate that a 6 month-security yields, but only have to reissue the debt every 3 years.

I don't believe the transactional overhead is really a concern of the treasury, nor is this an altruistic move. I imagine that there is significant pressures to move the short-term yield upwards. The Fed has dropped a ton of money into the system to try to force interest rates down, and that train is about to stop.

Investors will begin to demand a higher rate on short-term securities from the treasury, and the market will overpower the Fed soon. If, instead of issuing short-term T-Bills, the Treasury issues 3-year floating rate notes, then investors may accept a lower interest rate up front at issuance, on the basis that if the rates rise, they are covered. Here's a simplified example of my thought process:

The Treasury has to issue $10B of debt. There are 100 buyers, each who want to invest equally with $100M. 50 of those buyers are really worried about interest rates rising. 50 of those buyers are neutral and just need to park cash in a short term basis.

The neutral buyers are willing to take whatever market rate the treasury issues at auction because they don't really care. The 50 scared buyers will put in bids at the auction at a higher rate, because they are worried about rising rates in the near term.  If the Treasury issued all $10B in nominal-rate T-Bills, then the 50 scared buyers would drive up the rate for everyone.

If however, the treasury issues $5B in t-bills at nominal rate and $5B in floating note 3 year securities, then all the scared investors will flock to the floating notes, and the neutral investors will flock to the t-bills.

Without the scared investors bidding on the nominal rate securities, the yield stays low since the neutral people just take whatever. The scared investors get screwed because their floating note securities are taking the rate that the neutral people bid on, which is lower than what would have occurred if both pools of investors solely bid on nominal-rate T-Bills.

By "neutral" investor, I am referring to pension fund managers that have millions of dollars in "cash" positions and because of organizational constraints, are required to maintain themselves in cash positions of a specific maturity. It's possible they may not even be allowed to invest in the new floating note securities.

By "scared" investors I am referring to hedge fund managers with few restrictions who want to keep a portion of their assets in "cash" but are savvy and able to move assets into different types of securities at their discretion.

Is this a conspiracy theory, or is there some merit into this? If a dumb 30 y/o with an MBA (me) figured this out, then certainly hedge fund mangers will figure it out too, and the market will be efficient and drive up the short-term rates at the same time as the floating notes are issued.

This brings us to whether we should invest in it in the PP? I'd say no, because on an individual investor level, the transactional benefit of doing this is small compared to the risk of unknown securities doing something weird.

TripleB, I suppose with QE and such like, the idea that the market is setting yields is becoming ever more of a charade. Might this be just one more relaxation of the formalities of that charade? Perhaps in the future there will just be perpetual bonds with variable rate set by the government at whatever rate it considers fit. All curencies are competing to devalue. That really turns things upsidedown. They are each trying to be more unattractive than anything else. If QE can be brought in to buy up any bonds issued, bonds don't ever need to attract investors.

What would yields on s-t treasuries really be if the fed wasn't enacting QE?  This is the big mystery to me, as QE tends to simultaneously increase inflation worries, increase recovery hopes, but all as the result of lowering bond yields (kind of a paradox that this can all happen to any significant degree).  It seems like in many ways the market is setting these low yields, as the demand for short-term safe places to park cash is extremely high, and the demand for debt is extremely low.

Remember the only way to collect interest is to have somone borrow cash from you.  If there's nobody there to borrow money to, a lot of savers have to compete for the same borrower.

Considering the demand for treasury money market funds by holders of the dollar, I'm not surprised to see rates super low on the short end of the curve, regardless of what the fed is trying to do.

moda0306 wrote:Remember the only way to collect interest is to have somone borrow cash from you.  If there's nobody there to borrow money to, a lot of savers have to compete for the same borrower.

That reminds me of something... When the Clinton administration was setting up a plan to pay off the national debt by 2012, they realized that paying off the debt would mean that there would be no more US Treasuries being issued. And if there weren't any Treasuries being issued, it would cause some very big problems (i.e. no risk free assets). Here's a fascinating look at a secret memo (recently accessed by NPR, via the Freedom of Information ACT) about life after debt...

NPR: What If We Paid Off The Debt? The Secret Government Report

You can read the previously secret memo, here.

And If US Treasuries no longer existed, a US Permanent Portfolio wouldn't be possible!

Gumby isn't it true that Norway, Australia and previously Iceland!! are examples of countries that have simultaneously issued government bonds and run big surpluses? Think of the tax as annuling money- the government spends one dollar on public services, sells one dollar worth of bonds and annuls two dollars through taxation. MMTers say that the government bonds have nothing to do with raising income- they are simply a government service to the finance industry/ tool for ensuring financial stability.

stone wrote: Gumby isn't it true that Norway, Australia and previously Iceland!! are examples of countries that have simultaneously issued government bonds and run big surpluses? Think of the tax as annuling money- the government spends one dollar on public services, sells one dollar worth of bonds and annuls two dollars through taxation. MMTers say that the government bonds have nothing to do with raising income- they are simply a government service to the finance industry/ tool for ensuring financial stability.

I actually wasn't aware of those three examples, but yes, that makes perfect sense.