Presentation to the Treasury Borrowing Advisory Committee...1-Month TED (Treasury - Eurodollar)...
Transcript of Presentation to the Treasury Borrowing Advisory Committee...1-Month TED (Treasury - Eurodollar)...
Presentation to the Treasury Borrowing Advisory Committee
U.S. Department of the Treasury Office of Debt Management
July 29, 2008
2Office of Debt Management
Volatility across credit market sectors continue
CBOE Market Volatility Index, VIX
5
10
15
20
25
30
35
40
Aug-
06
Oct
-06
Nov
-06
Dec
-06
Feb-
07
Mar
-07
May
-07
Jun-
07
Aug-
07
Sep-
07
Oct
-07
Dec
-07
Jan-
08
Mar
-08
Apr-
08
May
-08
Jul-0
8
1-Month TED (Treasury - Eurodollar) Spread
0.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
Aug-
06
Sep-
06
Nov
-06
Dec
-06
Feb-
07
Mar
-07
Apr-
07
Jun-
07
Jul-0
7
Aug-
07
Oct
-07
Nov
-07
Jan-
08
Feb-
08
Mar
-08
May
-08
Jun-
08Asset Backed Commercial Paper Outstanding
(SA, Bil$)
500
600
700
800
900
1000
1100
1200
1300
01-O
ct-0
3W
24-M
ar-0
4W
15-S
ep-0
4W
09-M
ar-0
5W
31-A
ug-0
5W
22-F
eb-0
6W
16-A
ug-0
6W
07-F
eb-0
7W
01-A
ug-0
7W
23-J
an-0
8W
16-J
ul-0
8W
Moody's Seasoned Baa/Aaa Corporate Bond Spread
0.75
1.00
1.25
1.50
1.75
Aug-
06
Oct
-06
Nov
-06
Jan-
07
Feb-
07
Apr-
07
May
-07
Jul-0
7
Aug-
07
Oct
-07
Nov
-07
Jan-
08
Feb-
08
Apr-
08
May
-08
Jul-0
8
3 Month LIBOR - OIS Spread
0
20
40
60
80
100
120
04/0
1/07
05/0
1/07
06/0
1/07
07/0
1/07
08/0
1/07
09/0
1/07
10/0
1/07
11/0
1/07
12/0
1/07
01/0
1/08
02/0
1/08
03/0
1/08
04/0
1/08
05/0
1/08
06/0
1/08
07/0
1/08
LIB
OR
- O
IS S
prea
d in
bps
3Office of Debt Management
But Treasury settlement fails have fallen from their April peak
Primary Dealer Treasury Security Settlement FailsInterest Rate Environment
0
50
100
150
200
250
300
350
1/4/
1995
7/4/
1995
1/4/
1996
7/4/
1996
1/4/
1997
7/4/
1997
1/4/
1998
7/4/
1998
1/4/
1999
7/4/
1999
1/4/
2000
7/4/
2000
1/4/
2001
7/4/
2001
1/4/
2002
7/4/
2002
1/4/
2003
7/4/
2003
1/4/
2004
7/4/
2004
1/4/
2005
7/4/
2005
1/4/
2006
7/4/
2006
1/4/
2007
7/4/
2007
1/4/
2008
7/4/
2008
$ Billions
0.00
1.00
2.00
3.00
4.00
5.00
6.00
7.00
8.00Percent
Weekly Effective Fed Funds Rate
Average Daily Fails to Receive
Source: FRBNY FR2004 Settlement Fails Data & FRB H.15
4Office of Debt Management
The private sector continues to make progress on initiatives to address Treasury security fails
Since the May refunding, SIFMA and the Treasury Market Practices Group (TMPG) jointly are addressing:
Fails Best Practices: SIFMA/TMPG plan to issue a final document in August 2008.Fails Monitoring Committee: Operational in August 2008 after Fails Best Practices are issued. Mini-Closeout Provisions for the MRA: To be issued this quarter. SIFMA's buy-in procedures - Engaged in discussions with Treasury staff on new cash settlement feature. Prompt Delivery Trading Practices and Negative Rate Repo Trading - Both are available, but not used frequently. SIFMA plans 3 month study with recommendations. Fails Margining: Operationally possible for repos, but challenges remain for margining of cash fails.
5Office of Debt Management
From a fiscal perspective, borrowing requirements have increased since the beginning of the year
Fiscal Year to Date Deficits (monthly data)
-49
-80
-162
-258
-81
-148
-121
-157
-274
-163
-56
-154
-106
-88
-311
-152
-319
-269
-42
-122
-263
-350
-300
-250
-200
-150
-100
-50
0
Oct
-06
Nov
-06
Dec
-06
Jan-
07
Feb-
07
Mar
-07
Apr-0
7
May
-07
Jun-
07
Jul-0
7
Aug-
07
Sep-
07
Oct
-07
Nov
-07
Dec
-07
Jan-
08
Feb-
08
Mar
-08
Apr-0
8
May
-08
Jun-
08
$ Billions
-80%
-60%
-40%
-20%
0%
20%
40%
60%
80%
100%
120%
140%
2007 Y-O-Y % Change2008
6Office of Debt Management
Year-over-year growth in receipts is weaker than last year while growth in outlays continues
Individual and Corporate Tax Receipts Fiscal Year to Date
0
200
400
600
800
1000
1200
1400
1600
1800
Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
$ billions
0
200
400
600
800
1000
1200
1400
1600
1800$ billions
FY 2003FY 2004FY 2005FY 2006FY 2007FY 2008
2004 2005 2006 2007 20084.9% 21.0% 17.2% 11.4% -4.3%
Year-Over-Year Growth in Cumulative
End of FY Q3Individual and Corporate Tax Receipts
Total OutlaysFiscal Year to Date
0
500
1000
1500
2000
2500
3000
Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
$ billions
0
500
1000
1500
2000
2500
3000$ billions
FY 2003FY 2004FY 2005FY 2006FY 2007FY 2008
2004 2005 2006 2007 20086.7% 7.0% 8.8% 2.5% 6.6%
Year-Over-Year Growth in Cumulative Outlays End of FY Q3
7Office of Debt Management
Withheld tax growth appears to be following trends in corporate taxes
Rolling 12-Month Growth Rates
-30%
-20%
-10%
0%
10%
20%
30%
40%
Dec-81 Dec-84 Dec-87 Dec-90 Dec-93 Dec-96 Dec-99 Dec-02 Dec-05 Dec-08 Dec-11
Period ending
Corp Taxes WH Tax
Change in Nonfarm Payrolls (SA, Thousands) and the Civilian Unemployment Rate
-300
-200
-100
0
100
200
300
400
Jan-03 Jun-03 Nov-03 Apr-04 Sep-04 Feb-05 Jul-05 Dec-05 May-06 Oct-06 Mar-07 Aug-07 Jan-08 Jun-080%
1%
2%
3%
4%
5%
6%
7%
Monthly Change in Nonfarm Payrolls (LHS) Civilian Unemployment rate (RHS)
8Office of Debt Management
Primary Dealer Estimates for the FY 2008 deficit average $413 billion, virtually unchanged from $414 billion in November 2007
FY 08 Deficit Estimates $ billions
Primary Dealers* CBO OMB
Current: 413 396 389
Range based on average absolute forecast error 375-451 319-473 345-433
Estimates as of: July 08 March 08 July 08Note: Ranges based on errors from 2003-2007.* Primary Dealers reflect average estimate.
9Office of Debt Management
Large SLGS redemptions increase marketable borrowing needs
State and Local Governments (SLGS)Calendar Year
-20
-10
0
10
20
30
40
1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
$ B
illio
ns
10Office of Debt Management
Since the beginning of FY2008, the Fed’s holdings of Treasuries have declined by $300 billion as new liquidity tools have been introduced
S O M A H o l d i n g s o f B i l l s , N o m i n a l C o u p o n s a n d T I P S
$ 0
$ 1 0 0
$ 2 0 0
$ 3 0 0
$ 4 0 0
$ 5 0 0
$ 6 0 0
$ 7 0 0
$ 8 0 0
$ 9 0 0
12/1
8/20
02
2/18
/200
3
4/18
/200
3
6/18
/200
3
8/18
/200
3
10/1
8/20
03
12/1
8/20
03
2/18
/200
4
4/18
/200
4
6/18
/200
4
8/18
/200
4
10/1
8/20
04
12/1
8/20
04
2/18
/200
5
4/18
/200
5
6/18
/200
5
8/18
/200
5
10/1
8/20
05
12/1
8/20
05
2/18
/200
6
4/18
/200
6
6/18
/200
6
8/18
/200
6
10/1
8/20
06
12/1
8/20
06
2/18
/200
7
4/18
/200
7
6/18
/200
7
8/18
/200
7
10/1
8/20
07
12/1
8/20
07
2/18
/200
8
4/18
/200
8
6/18
/200
8
W e e k E n d i n g
SO
MA
Por
tfolio
(Bill
ions
)
T I P S ( M i l , $ ) N o m in a l C o u p o n s (M i l , $ ) B i l ls ( M i l , $ )
Fiscal Yearto Date
October November December January February March April May June July 9, 2008 Change
TAF 0 0 0 44 60 70 100 125 150 150 150
PDCF 0 0 0 0 0 23* 27 15 8 0 0
Discount Window 0 0 3 2 0 0 9 14 14 13 13
28-day RPs** 0 0 0 0 0 60 80 80 80 80 80
Authorized Currency Swaps 0 0 18 24 36 36 36 62 62 62 62
TSLF 0 0 0 0 0 0 118 128 104 104 104
Total 0 0 21 68 96 189 370 424 418 409 409
Outright Treasury Holdings 780 780 770 728 713 682 559 514 482 479 -301
* 2-week average ** Outstanding end of month
Liquidity Tools
(Monthly Averages, $ Billions)Federal Reserve Liquidity Tools and Oughtright Treasury Holdings
11Office of Debt Management
Treasury has made over $90 billion in stimulus payments year to date.$
billi
ons
Cumulative 2008 Fiscal Stimulus Payments
0
10
20
30
40
50
60
70
80
90
100
4/22 5/6 5/20 6/3 6/17 7/1 7/15 7/29 8/12 8/26 9/9 9/23 10/7 10/21 11/4 11/18 12/2 12/16
$ bi
llion
s
YTD 7/26: $93.7 billion
FY09: $3.5 BFY08: $95.7 B
Total Estimated Fiscal Stimulus Payments
(thru 12/08):
FY08: $95.7 billion FY09: $3.5 billion Total: $99.1 billion
12Office of Debt Management
Mitigating volatility in cash balances resulting from net receipts, redemptions, and other factors remains challenging
Treasury Daily Operating Cash Balance
0
25
50
75
100
125
150
Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep
$ billions
0
25
50
75
100
125
150$ billions
Note: Data through July 21, 2008.
13Office of Debt Management
Growth in marketable financing needs has led to increased issuance of cash management bills with some extending over fiscal year end
$ b
illion
s
Cash Management Bill Issuance(FY 2006 - FY 2008)
FY07FY08
FY06
0
50
100
150
200
250
300
350
10/1 10/31 11/30 12/30 1/29 2/28 3/29 4/28 5/28 6/27 7/27 8/26 9/25
$ bi
llions
14Office of Debt Management
In addition, nominal coupon security issuance has been increased in response to borrowing needs
Coupon Issuance in 2007-2008
$10.00
$15.00
$20.00
$25.00
$30.00
$35.004/
2/20
07
5/2/
2007
6/2/
2007
7/2/
2007
8/2/
2007
9/2/
2007
10/2
/200
7
11/2
/200
7
12/2
/200
7
1/2/
2008
2/2/
2008
3/2/
2008
4/2/
2008
5/2/
2008
6/2/
2008
7/2/
2008
Size
of L
ast O
fferin
g (b
illio
ns)
2-Year (Monthly)
10-Year (Quarterly + Reopening)
5-Year (Monthly)
30-Year (Semi-Annual + Reopening)
15Office of Debt Management
The 2-year to 5-year sector continue to raise cash in response to recent borrowing needs
FY Cash Raised 2-Yr
(100)
(50)
-
50
100
150Oct-05 Oct-06 Oct-07 Oct-08
Billio
ns o
f dol
lars
FY Cash Raised 3-Yr
(150)
(100)
(50)
-
50
100
150Oct-05 Oct-06 Oct-07 Oct-08 Oct-09
Billio
ns o
f dol
lars
FY Cash Raised 5-Yr
(50)
-
50
100
150Oct-05 Oct-06 Oct-07 Oct-08 Oct-09
Billio
ns o
f dol
lars
FY Cash Raised 2-5 Yr Sector
(100)
(50)
-
50
100
150Oct-05 Oct-06 Oct-07 Oct-08 Oct-09
Billio
ns o
f dol
lars
Forecasts of cash raised in future months assume that offering amounts will remain the same as those of July 2008.
16Office of Debt Management
Note though that in FY 2009, maturing 3-yr notes and 5-yr notes create sizable redemptions
Coupons Maturing*July 31, 2008-February 15, 2038
0
10
20
30
40
50
60
70
80
31-J
UL-
2008
15-A
UG
-200
831
-AU
G-2
008
15-S
EP-2
008
30-S
EP-2
008
15-O
CT-
2008
31-O
CT-
2008
15-N
OV-
2008
30-N
OV-
2008
15-D
EC-2
008
31-D
EC-2
008
15-J
AN-2
009
31-J
AN-2
009
15-F
EB-2
009
28-F
EB-2
009
15-M
AR-2
009
31-M
AR-2
009
15-A
PR-2
009
30-A
PR-2
009
15-M
AY-2
009
31-M
AY-2
009
15-J
UN
-200
930
-JU
N-2
009
15-J
UL-
2009
31-J
UL-
2009
15-A
UG
-200
931
-AU
G-2
009
15-S
EP-2
009
30-S
EP-2
009
15-O
CT-
2009
31-O
CT-
2009
15-N
OV-
2009
30-N
OV-
2009
15-D
EC-2
009
31-D
EC-2
009
15-J
AN-2
010
31-J
AN-2
010
15-F
EB-2
010
28-F
EB-2
010
15-M
AR-2
010
31-M
AR-2
010
15-A
PR-2
010
30-A
PR-2
010
15-M
AY-2
010
31-M
AY-2
010
15-J
UN
-201
030
-JU
N-2
010
15-J
UL-
2010
15-A
UG
-201
015
-SEP
-201
015
-OC
T-20
1015
-NO
V-20
1015
-DEC
-201
015
-JAN
-201
115
-FEB
-201
128
-FEB
-201
131
-MAR
-201
115
-APR
-201
130
-APR
-201
131
-MAY
-201
130
-JU
N-2
011
31-J
UL-
2011
15-A
UG
-201
131
-AU
G-2
011
30-S
EP-2
011
31-O
CT-
2011
30-N
OV-
2011
31-D
EC-2
011
15-J
AN-2
012
31-J
AN-2
012
15-F
EB-2
012
29-F
EB-2
012
31-M
AR-2
012
15-A
PR-2
012
30-A
PR-2
012
31-M
AY-2
012
30-J
UN
-201
215
-JU
L-20
1231
-JU
L-20
1215
-AU
G-2
012
31-A
UG
-201
230
-SEP
-201
231
-OC
T-20
1215
-NO
V-20
1230
-NO
V-20
1231
-DEC
-201
231
-JAN
-201
315
-FEB
-201
328
-FEB
-201
331
-MAR
-201
315
-APR
-201
330
-APR
-201
315
-MAY
-201
331
-MAY
-201
330
-JU
N-2
013
15-J
UL-
2013
15-A
UG
-201
315
-NO
V-20
1315
-JAN
-201
415
-FEB
-201
415
-MAY
-201
415
-JU
L-20
1415
-AU
G-2
014
15-N
OV-
2014
15-J
AN-2
015
15-F
EB-2
015
15-M
AY-2
015
15-J
UL-
2015
15-A
UG
-201
515
-NO
V-20
1515
-JAN
-201
615
-FEB
-201
615
-MAY
-201
615
-JU
L-20
1615
-AU
G-2
016
15-N
OV-
2016
15-J
AN-2
017
15-F
EB-2
017
15-M
AY-2
017
15-J
UL-
2017
15-A
UG
-201
715
-NO
V-20
1715
-JAN
-201
815
-FEB
-201
815
-MAY
-201
815
-JU
L-20
1815
-NO
V-20
1815
-FEB
-201
915
-AU
G-2
019
15-F
EB-2
020
15-M
AY-2
020
15-A
UG
-202
015
-FEB
-202
115
-MAY
-202
115
-AU
G-2
021
15-N
OV-
2021
15-A
UG
-202
215
-NO
V-20
2215
-FEB
-202
315
-AU
G-2
023
15-N
OV-
2024
15-J
AN-2
025
15-F
EB-2
025
15-A
UG
-202
515
-JAN
-202
615
-FEB
-202
615
-AU
G-2
026
15-N
OV-
2026
15-J
AN-2
027
15-F
EB-2
027
15-A
UG
-202
715
-NO
V-20
2715
-JAN
-202
815
-APR
-202
815
-AU
G-2
028
15-N
OV-
2028
15-F
EB-2
029
15-A
PR-2
029
15-A
UG
-202
915
-MAY
-203
015
-FEB
-203
115
-APR
-203
215
-FEB
-203
615
-FEB
-203
715
-MAY
-203
715
-FEB
-203
8
$ Billions
10 YR IIS NOTE 10 YR NOTE 2 YR NOTE
20 YR IIS BOND 3 YR NOTE 30 YR BOND
30 YR IIS BOND 5 YR IIS NOTE 5 YR NOTE
*Based on coupon securities outstanding as of July 31, 2008.
17Office of Debt Management
Given Treasury’s financing needs in the coming years as well as current and medium-term trends in the economic outlook, what are the Committee’s thoughts on Treasury’s debt issuance?
In particular, we would like the Committee’s advice on whether the recent adjustments to the financing schedule provide Treasury with sufficient debt management tools to handle a wide range of budgetary and financing outcomes, or if additional adjustments should be considered.
Credit Market Conditions
Treasury Borrowing Advisory Committee Presentation to the U.S. Treasury
July 28, 2008
2
I. Funding Strains & Libor/OIS SpreadsII. Assessing the New Fed FacilitiesIII. Investor Activity
3
• I. Funding Strains & Libor/OIS Spreads
4
Libor/OIS spreads
• Funding strains in Money Markets quickly escalated during August 2007 as interbank liquidity diminished and European Bank demand for USD increased. 75bps of easing in the FF target level by November brought spreads in; however, year- end funding pressure saw that narrowing reverse with Libor/OIS spreads reaching a high of 110bps in early December.
• The introduction of TAF on Dec 12, 2007 quickly improved conditions as the market anticipated that the 40bn in USD provided via the US TAF would ease funding strains into year-end.
• A further increase in the size of TAF announced on January 4, 2008 sent spreads to their tightest levels since early August; however, disruption to global equity markets unwound this in January.
• Since then, further TAF size increases and the introduction of the TSLF and PDCF have reduced the term interbank premium in 1-month money, while 3-month money trades persistently in a 60-80bps spread to 3-month OIS.
• TAF and its subsequent increases appear to have had the largest impact on Libor/OIS spreads and the introduction of a 3- monrh TAF would likely help to narrow the gap between 1-month and 3-month Libor.
Spot Libor / OIS spre ads
0
20
40
60
80
100
120
May-07 Jul-07 Sep -07 Nov-07 Jan-08 Mar-08 May-08
spre
ad (b
ps)
Spot 3mL - Spot 3m OIS Spot 1mL - Spot 1m OIS
1 - 12/12/07 TAF announced, f irst auction 12/17 for 12/20 settle, bi-w eekly 40b total
3- 3/7/08 TAF increased to 100b f rom 60b, 28-day single tranche repo operations launched : f irst auction 3/7 for 3/10 settle
4- 3/11/08 TSLF introduced, f irst auction 3/27 for 3/28 settle
5- 3/16/08 PDCF introduced
6- 5/2/08 TAF size increased to 150bn f rom 100b
1
3
4
5 62
2- 1/4/08 TAF increased to 60b f rom 40b
5
Libor/OIS in Perspective
• While the volatility and outright levels in Libor/OIS swaps are extreme by historical standards, it is difficult to point to one explanatory factor.
• Before the launch of the TSLF in March, the spread between 3-month MBS repo and 3- month TSY repo explained roughly 50% of the variation in Libor/OIS spreads. US Bank CDS is even less correlated, implying that the move in Libor/OIS spreads is likely a function of a dynamic combination of balance sheet pressures, liquidity concerns, credit risk, and an embedded market fear premium, as well as a general preference for holding cash over lending.
Libor/O IS in P ers pec tive
0
20
40
60
80
100
120
Feb-02 Feb-03 Feb-04 Feb-05 Feb-06 Feb-07 Feb-08
spre
ad (i
n bp
s)
Spot 3mL - 3m OIS Spot 1mL - 1m OIS
Libor/OIS, Funding & CDS
0
50
100
150
200
May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08
Valu
e (b
ps)
Spot 3mL - 3m OIS 3mo mbs -tsy repo US Bank 5yr CDS
* Bank CDS index wtd avg o f BOA, Citi, JP M Chase, Wacho via, Wells Fargo
6
• II. Assessing the New Fed Facilities
7
Assessing TAF
• Early TAF results were well behaved but began to trade much closer to interbank levels than OIS during March. At the same time, concerns that the Libor fixing process understated the true cost of borrowing in the interbank market were reinforced when the TAF stopped above 1-month Libor on March 24th and April 7th. We think that the presence of Discount Window stigma might have had a hand in TAF trading like the interbank market as banks were willing to pay-up to secure money away from the Discount Window.
• On May 2nd, the size of the TAF was increased to 150b from 100b, which reset the stop levels closer to OIS and brought the bid-to-cover down closer to 1.
• Recent stability in clearing spreads, bid-to-cover and the number of participating institutions indicates that 150b is an appropriate amount of 1-month money for the market at this time. However, the steepness of 1- month/3-month Libor indicates an embedded term premium for longer dated funding that could be reduced by a longer tenor TAF auction.
TAF Results
1.75
2.25
2.75
3.25
3.75
4.25
4.75
12/1
7/07
12/3
1/07
1/14
/08
1/28
/08
2/11
/08
2/25
/08
3/10
/08
3/24
/08
4/7/
08
4/21
/08
5/5/
08
5/19
/08
6/2/
08
6/16
/08
6/30
/08
7/14
/08
Rat
e (in
%)
Min Bid Stop 1mo L fix Discount Rate
TAF Bid-to-Cover & Partic ipating Ins titutions
0
0.5
1
1.5
2
2.5
3
3.5
12/1
7/07
12/3
1/07
1/14
/08
1/28
/08
2/11
/08
2/25
/08
3/10
/08
3/24
/08
4/7/
08
4/21
/08
5/5/
08
5/19
/08
6/2/
08
6/16
/08
6/30
/08
7/14
/08
Bid-
to-C
over
0
10
20
30
40
50
60
70
80
90
100
# Part. Inst.
bid:cover (LHS) # ins t. (RHS) A uction Size (RHS)
8
Assessing TSLF
• The TSLF was not as popular with the primary dealer community as TAF was for the banking community given that TSLF is a collateral swap and thus provides less value-added vs. TAF. The collateral schedule is more restrictive and is an auction for TSY tri-party repo instead of cash.
• The amount of TSY in the market supplied by the Fed via TSLF and the sterilization of their other liquidity platforms (approx 430bn) cheapened TSY repo a tremendous amount.
• Overnight TSY repo had been trading at close to a 150bp spread to FF effective in late March and cheapened to 2-5bps by mid-May. This cheapening narrowed the funding spread between TSLF collateral classes, which rendered the TSLF less attractive.
• In late July, widening in the MBS/TSY repo spread saw the Schedule 1 TSLF garner more interest as the facility became an attractive method for MBS funding.
1mo MBS vs 1mo TSY Repo
0
10
20
30
40
50
60
70
80
90
Mar-08 Apr-08 May-08 May-08 Jun-08 Jul-08
spre
ad (i
n bp
s)
1mo mbs - tsy repo
TSLF Bid-to-Cover
00.20.40.60.8
11.21.41.61.8
22.2
3/27
/08
4/3/
08
4/10
/08
4/17
/08
4/24
/08
5/1/
08
5/8/
08
5/15
/08
5/22
/08
5/29
/08
6/5/
08
6/12
/08
6/19
/08
6/26
/08
7/3/
08
7/10
/08
7/17
/08
Schedule 1 bid:cover Schedule 2 bid:cover
9
The impact on TSY repo
• The cheapening of overnight TSY repo caused by the sterilization of the Fed’s liquidity platforms and the introduction of TSLF decreased the term premium in TSY repo.
• The Fed’s outright sales caused some disruption to relative value trades and in the near-term increased the float of many securities.
• As a result the number of securities trading special declined as evidenced by a drop in SOMA borrowings, which had peaked above 20bn in both March and May. Treasuries continue to trade special around month- ends, but the increase in market TSY supply has broadly cheapened TSY repo.
Relative Value of TSYs
0
1
2
3
4
5
6
May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08
Rat
e (%
)
1mo OIS 1mo tsy repo
SOMA Daily Borrowings (MM)
0
5,000
10,000
15,000
20,000
25,000
Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08
amt (
mm
)
Daily Borrow ing Amount (MM)
10
Assessing the 28-day Repo Operations
• The Fed’s 28-day single tranche repo operations continue to be more popular than the Fed’s Schedule 1 TSLF simply because primary dealers find more value to receiving cash from the Fed.
• As the spread between TSY and MBS repo narrowed during May, the amount of money bid for in the 28-day operations declined suggesting that financing conditions & liquidity for other asset classes was improving. However, the latest GSE inspired flight-to-quality bid has made the 28-day repo operations an attractive alternative for GSE MBS funding.
1m o M B S vs 1m o TS Y R epo
0
10
20
30
40
50
60
70
80
90
Mar -08 A pr-08 May -08 May -08 Jun-08 Ju l-08
spre
ad (i
n bp
s)
1mo mbs - ts y repo
28-day S ingle Tranche Repo Operations
0.00
0.50
1.00
1.50
2.00
2.50
3.00
Mar-08 A pr-08 May-08 Jun-08 Jul-08
Rat
e (in
%)
0
10
20
30
40
50
60
70
80
90
$ amt in bn
Stop (LHS) 1mo OIS (LHS) $ bid for (RHS)
11
Assessing the PDCF
• The PDCF and Primary Credit Discount Window borrowings continue to show that the dealer community’s funding position is improving while the bank community’s needs have stabilized.
• The introduction of the PDCF realized an immediate contraction in Libor/OIS spreads in late March. However, as write- down concerns continued into April, those spreads widened out. It seems as if May’s TAF size increase has had more of a lasting impact on Libor/OIS spreads than the PDCF. Yet, it is difficult to assess how the presence of the PDCF might have prevented Libor/OIS spreads from widening back to the December highs.
Average Daily PDCF and D is count Window Borrow ings
0
5
10
15
20
25
30
35
40
3/26
/08
4/2/
08
4/9/
08
4/16
/08
4/23
/08
4/30
/08
5/7/
08
5/14
/08
5/21
/08
5/28
/08
6/4/
08
6/11
/08
6/18
/08
6/25
/08
7/2/
08
7/9/
08
7/16
/08
7/23
/08
$ am
t in
bn
PDCF Primary Credit Discount Window
12
Risk Premium in T-Bills and Repo
• The sterilization of the Fed’s liquidity platforms and the introduction of the TSLF have brought approximately 400bn in TSY supply to the market. In addition to this, Treasury issuance remains at record levels, both of which served to cheapen T-Bills and TSY repo dramatically vs. OIS during May and June (3-month T-Bills traded at a 12bp spread to OIS and 3-month repo at flat to OIS).
• That being said, the most recent wave of flight-to-quality buying in the wake of uncertainty over the GSE’s has seen T-Bills and TSY repo richen again. However, we currently trade at levels far cheaper than we did in March and also at levels that are not extremely rich versus 2006. This indicates that the array of liquidity provisions that the Fed has instituted are certainly helping to stabilize the market. Conditions generally feel better now than they did in March despite the fact that the GSE issue has the potential to be much larger and more complicated in scope than the Bear crisis.
13
Risk Premium in T-Bills and Repo
200
300
400
500
600
700
800
900
Nov Dec Jan Feb Mar Apr May Jun Jul200
300
400
500
600
700
800
900
Swap LinesPDCFTerm Auction Facility28-Day ReposOther Repurchase AgreementsTSLF (Part of Securities Held, Pledged in Collateral Exchange)
Billions of dollars Billions of dollars
Source: Federal Reserve Board.2007 2008
Securities Held Outright
• Where are the TSYs coming from? – YoY T-Bill Outstanding : +350bn– TSLF Collateral Swap : +123bn– Sterilizing Liquidity Facilities:
+ TAF: 150bn+ Swap Lines to ECB/SNB: 62bn+ PDCF @ zero presently+ Discount Window: 17.8bn+ Single Tranche Repo: 80bn
TOTAL = 782.8bn *data as of 7/23/08
Regular Weekly T-Bill Outstanding (does not include CM Bills)
700
800
900
1000
1100
1200
1300
Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08
amou
nt (b
n)
Regular Weekly T-Bill Outstanding
Relative Value of T-Bills & Tsy Repo vs OIS
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08
spre
ad (i
n bp
s)
3mo T-Bill - 3mo OIS 3mo Tsy Repo - 3mo OIS
14
Demand for USD
• Lastly, the euro/usd basis swap also demonstrates that the Fed’s liquidity measures are helping to stabilize the USD financing markets, as the basis swap has tightened since TAF was increased in May with no real reaction to the latest round of flight-to-quality buying in TSY. (This is the spread to Euribor at which you can lend euros to borrow usd at Libor flat – a negative spread indicates stronger USD demand)
1mo Euro / USD bas is swap
-65
-55
-45
-35
-25
-15
-5
5
15
Jul-0
6
Sep-
06
Nov
-06
Jan-
07
Mar
-07
May
-07
Jul-0
7
Sep-
07
Nov
-07
Jan-
08
Mar
-08
May
-08
Jul-0
8
basi
s (in
bps
)
1mo Euro / USD bas is sw ap
15
• III. Investor Activity
16
Investor Activity : Repo
• The general trend has been for clients to assess their counterparty risks and to act in a more deliberate, if not conservative, fashion.
• In Repo, we have seen a variety of reactions from our client-base including:» Business as usual» Execution of term repo to capture larger spreads» Shortening repo duration» Shying away from certain asset types» Increasing haircuts on certain asset types
17
Issues Surrounding Tri-Party Repo
• In our opinion, the recent concern over the potential for tri-party repo to cause systemic failure is a bit misplaced as a sensible approach to developing ‘best practices for liquidity management’ would counter-act these concerns.
• The main issue is that the tri-party clearing agents bear intra-day credit exposure against their clients which could cause problems if one of these clients were unable to roll their funding or if one of the agents themselves were to have a liquidity problem.
• This implies that the issue can be resolved if the clearing agents are prudent in their analysis of and willingness to provide intra-day credit.
• Assessing the Net-Free Equity position of a client, hair-cutting appropriately for the collateral type and credit quality of the counterpart, and avoiding large maturity dates (i.e. staggering maturities across various term dates) will mitigate the risks that the clearing agents are assuming.
• The benefits of the financing liquidity provided by the tri-party repo system are maintained and safe-guarded by employing a conservative approach to liquidity management.
18
Investor Activity : T-Bills
• In T-Bills, we saw flight-to-quality investing from all account types including Central Banks, Money Funds, Hedge Funds and Corporations. As cash poured into Money Funds and was re- allocated to All-Government Funds, T-Bills richened dramatically vs. OIS last August. As All-Government Fund assets reached record levels, a significant bid to T-Bills remained constant.
• The sterilization of the Fed’s Liquidity Facilities and record TSY issuance began to weigh on the market in April. In addition, as TSY repo cheapened the negative carry in short-dated T-Bills was also a driving force behind their sell-off. A steady bid eventually absorbed the supply increase and T-Bills have since richened on renewed flight-to-quality buying. Domestic Money Funds have preferred to invest in 3-month and shorter T-Bills in order to keep their WAMs between 35 – 40 days. This caused 6month T-Bills to trade cheaper vs. OIS. Duration restrictions have also caused the new 1yr T-Bill to be largely dealer supported with light real money interest.
• Re-distribution of Money Fund assets, re-allocation into Equities and TSY issuance levels will be important drivers for T-Bill valuations going forward. In addition, an explicit Government backing of GSE debt could cause a large re-pricing as 800bn of Discount Notes could drive prices lower on supply fundamentals. The final theme that is likely to emerge at some point in the future will be TSY buy-backs. If the Fed winds down its liquidity platforms the T-Bill market will likely rally in anticipation of T-Bill buy-backs.
T-Bills & Tsy Repo vs OIS in Perspective
-200
-180
-160
-140
-120
-100
-80
-60
-40
-20
0
Dec-05 Apr-06 Aug-06 Dec-06 Apr-07 Aug-07 Dec-07 Apr-08
spre
ad (i
n bp
s)
3mo T-Bill - 3mo OIS 3mo Tsy Repo - 3mo OIS
Money Fund Assets
250
750
1250
1750
2250
May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08
size
(bn)
Govt Funds Prime Funds *Prime Funds include ho ldings o f ABCP, TSY, Repo, time deposits, dom. & fo r. obligations,
CP and FRNs
19
Investor Activity : Discount Notes
• The ongoing theme in Discount Notes this year was supply as FHLB, FNMA and FHLMC all reached record issuance levels. FHLB issuance rose dramatically due to increasing RMBS funding needs and balance sheet constraints.
• In May, 3-month and 6-month Discount Notes cheapened 30bps vs. OIS. Further uncertainty over the fate of the GSE’s saw substantial widening in mid-July.
• Very recent indications point towards full Government backing of their debt which has prompted Dealers, Money Funds and Central Banks to buy; tightening spreads. It has been difficult to place 6-month paper, thus we have seen better issuance to mid-December. As such, the Agencies appear to be accumulating larger Year-End roll-over risk.
Agency Discount Note Outstandings
100
150
200
250
300
350
400
450
Jan-06 May-06 Sep-06 Jan-07 May-07 Sep-07 Jan-08 May-08
Size
(bn)
FHLB FNMA FHLMC
Agency Discount Note Spreads vs. OIS
-5
5
15
25
35
45
55
65
75
5/5/08 5/19/08 6/2/08 6/16/08 6/30/08 7/14/08
Spre
ad in
Bps
6 Month 3 Month
20
Investor Activity : Credit
• The defining theme in credit has been spread widening and credit differentiation. In 1yr paper, top-tier banks now trade as much as 75bps tighter than weaker names (L+25 vs. L+100). Many investors went through a credit cleansing, re- building and reducing their ‘approved lists’ while generally preferring industrials over financials.
• Securities Lenders with SIVs exposure are maintaining more cash to compensate for potential withdrawals. This has shifted significant investment into 1-month and shorter investments. As the 2- and 3-yr FRN market dried up, extra funding demand rolled down the curve to meet smaller ‘approved lists’ thereby widening spreads.
• As we look forward, expanding ‘approved lists’, increasing duration and a shift back to focusing on returns will help to normalize shorter dated credit markets.
21
Investor Activity : Credit
Weekly Outstandings : AA Non-Financial, AA Financial, ABCP
0
200
400
600
800
1000
1200
May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08
size
(bn)
AA Non-Financial AA Financial ABCP
Credit Differentiation Amongst Industrials: Spread Between A1/P1 Non-Financials and A2/P2 Non-Financials
020406080
100120140160
Aug-07 Oct-07 Dec-07 Feb-08 Apr-08 Jun-08
Spre
ad in
bps
1mo A2/P2 Non-Fin - 1mo A1/P1 Non-Fin
Financial, Non-Financial, and Asset-Backed CP Spreads to 1mo Libor
-100-80-60-40-20
020406080
100120
Aug-07 Oct -07 Dec-07 Feb-08 Apr-08 Jun-08
Spre
ad in
bps
to 1
mo
L
1mo AA Non-Financial CP 1mo AA Financial CP 1mo ABCP
Tier-1 vs Tier-2 Weekly CP Outstandings
0200400600800
100012001400160018002000
May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08
Size
(bn)
0102030405060708090100
Size (bn)
Tier-1 CP (LHS) Tier-2 CP (RHS)
22
Conclusions
• Increasing TAF to 150bn narrowed the 1-month Libor/OIS spread by approximately 40bps; stabilizing 1-month spreads and auction results. Providing a 3-month TAF would likely facilitate tightening in 1-month/3-month Libor spreads and 3-month Libor/OIS.
• Liquidity in T-Bills and TSY repo has improved dramatically in the last four months, in large part due to the increase in supply.
• In addition, a decline in the volatility of the daily Fed Funds effective rate has also made it easier to price OIS based money-market products such as term TSY repo.
• A gradual shift towards a focus on returns will further normalize Money Markets. In the meantime, the Fed’s new facilities, their sterilization and an increase in T-Bill issuance have all helped to bring needed stability and liquidity back to the risk-free assets: T-Bills and TSY repo.
23
TIPS and Inflation Trends
Treasury Borrowing Advisory Committee Presentation to the U.S. Treasury
July 28, 2008
24
Headline CPI, y oy
0
1
2
3
4
5
6
7
1988 1993 1998 2003 2008
Current Weighted contributionWeight in Headline CPI to headline CPI (yoy)
Core 76.5% 1.8%Housing 42.4% 1.5%Medical Care 6.2% 0.3%Education and communication 6.1% 0.2%
Food and beverages 14.9% 0.8%Energy 9.7% 2.4%
-40%
-20%
0%
20%
40%
60%
80%
Jul 93 Jul 96 Jul 99 Jul 02 Jul 05
S&P GSCI Index
Commodity prices have increased significantly over the past year bringing headline inflation to a pace last seen in the early ‘90s
1-year rolling percentage change of the S&P GS Commodity index (%)Crude oil and gold prices
Headline yoy CPI-U nsa (%)
Components of headline CPI versus their weighted contribution to headline CPI yoy
0
20
40
60
80
100
120
140
160
Aug 93 Aug 96 Aug 99 Aug 02 Aug 05 Aug 08
0
200
400
600
800
1000
1200
GoldCrude Oil
25
0
2
4
6
8
10
12
1978 1985 1992 1999 2006
1-y ear
5-y ear
Impact on inflation expectations (% points)
Driver Chg in driver 1Y forward 5Y forwardOil price 10% 0.08 0.00
Realized inflation (yoy) 1% point 0.43 0.08
Survey based inflation measures are surging, but history suggests that these measures are more reactive than predictive
1- and 5-year University of Michigan inflation expectations
Near term inflation expectations have historically increased as realized inflation has increased and oil prices have risen
Long term forward survey based inflation expectations are sticky, reacting to realized inflation with a lag …
… but eventually rise 1-for-1 with near term inflation expectations
The University of Michigan 5-year forward inflation expectations lagged the 1-year ahead expectations on the way up as well as down in the 1980 experience, but reached similar peak levels
1-year and 5-year Univ. of Michigan inflation expectations regressed against realized yoy headline CPI over past year and 6-month percentage change in oil prices
26
4%
6%
8%
10%
12%
14%
16%
1998 2000 2002 2004 2006 2008
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
TIPS
Nominals
0
2
4
6
8
10
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
1.0%
1.5%
2.0%
2.5%
3.0%
3.5%
Av g daily trading v olume, $bn
TIPS traded v olume as % ofdebt oustanding
TIPS trading volumes versus nominals
Average daily trading volume in TIPS ($bn) versus daily trading volume as percentage of TIPS outstanding
* 2008 numbers till May
Source: SIFMA
Average daily trading volume in TIPS as percentage of TIPS outstanding (Right axis) versus average daily trading volume in nominals as percentage of nominals outstanding (Left axis)
Trading volumes in TIPS seem to have reached a plateau, despite a continued increase in the size of the market indicating that TIPS is more of an investor’s market than a trader’s market
Daily turnover in the TIPS market as a percentage of total outstandings is approximately 13% that of nominals
27
Inflation linked market landscape
60708090
100110120130140150
Jul 07 Oct 07 Jan 08 Apr 08 Jul 08
-20-10010203040506070
5s/20s breakev en curv e (inv erted)
Oil pricesTIPS allow investors to diversify inflation risk in their fixed income portfolios
Additionally, the TIPS curve allows investors to express views on realized inflation as well as longer term inflation expectations
The key residual risk in TIPS is illiquidity and associated premiums
TIPS have not realized the same benefit of flight to quality that nominal Treasuries have
Private issuers have not embraced inflation linked funding due to lack of depth in demand and FAS 133-related issues
TIPS can help reduce Treasury borrowing costs, especially in an environment where inflation expectations increase
Diversifies the investor base for Treasuries
5s/20s par breakeven curve (bp) versus oil prices ($/bbl)
Liquidity premium** in TIPS versus Nominals (bp of yield)
** we use the TIPS asset-swap spread versus maturity matched nominal asset swap spread differential as a metric for the liquidity differential. Positive number denotes cost (to the Treasury) of issuing TIPS versus nominals, assuming inflation expectations are realized.
0
10
20
30
40
50
60
70
80
2004 2005 2006 2007 2008
5-y ear10-y ear20-y ear
28
-30-25-20-15-10
-505
1015202530
1997 1999 2001 2003 2005 2007
-40%
-30%
-20%
-10%
0%
10%
20%
30%
40%
Cumu. ex cess TIPS ex pense
Adjusted ex cess TIPS ex pense
0
20
40
60
80
100
120
140
Jan-97 Jul-98 Jan-00 Jul-01 Jan-03 Jul-04 Jan-06 Jul-07
Cumu. nominal ex pense
Cumu. TIPS ex pense
The aggregate cost of the TIPS program has increased in recent years, primarily because realized inflation has been higher than expectations
Estimated cumulative expense till July 2008 on all TIPS issued ($bn) versus estimated cumulative expense if similar maturity nominals had been issued instead ($bn)
Estimated excess cumulative expense till July 2008 on TIPS versus nominals ($bn, left axis) versus the excess TIPS expense/ total TIPS expense by year (%, Right axis)
Estimated annual expense on TIPS versus nominals as attributed to liquidity* and the difference between realized inflation and inflation expectations ($bn)
Estimated cumulative excess expense on TIPS versus nominals that may be attributed to liquidity premium of TIPS and the difference between realized inflation and breakevens
* We use the TIPS asset-swap spread versus maturity matched nominal asset swap spread differential at time of issue as a metric for the liquidity differential. For the period prior to 2004, we use the 2004-2008 average for asset swap differential. ** 2008 numbers have been calculated through July 15, and are not annualized.
Inflation v s. ex pectations
78%
Ex cess liquidity cost
22%
-9-8-7-6-5-4-3-2-1012
1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008
Inflation v s. breakev ensEx cess liquidity cost
**
29
0%5%
10%15%20%25%30%35%40%45%
<2y 2y to 5y 5y to 10y 10y to 20y 20y to 30y
TIPSNominals
0%5%
10%15%20%25%30%35%40%45%
<2y 2y to 5y 5y to 10y 10y to 20y 20y to 30y
TIPSNominals
Maturity profile of the TIPS market versus nominals
Current maturity profile of TIPS versus Nominals ($bn)
Projected* maturity profile of TIPS versus Nominals in 2-years ($bn)
* Assuming that the Treasury keeps current issuance calendar unchanged, but increases size of the 2-year nominal auction by $1bn, 5-year by $4bn, 10-year by $1bn and 30-year by $1bn. Sizes are assumed to be unchanged for TIPS.
Average and standard deviation of auction tails since 2006 by maturity ($bn)
A balance of nominal and TIPS issuance should, in the long run, reduce Treasury’s borrowing costs
The maturity profile of TIPS issuance should approximate that of nominals, and it currently largely does
Auction statistics suggest that demand for 20-year TIPS is driven by a small number of investors and it would be difficult to significantly increase borrowing at the long end of the TIPS curve
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
5 YR 10 YR 20 YR
Av erage tail
Standard dev iation