REPORT TO THE SECRETARY OF THE TREASURY 

FROM THE 

TREASURY ADVISORY COMMIlTEE 

OF THE 

BOND MARKET ASSOCLATION 

May6, 1998 

Dear Mr. Secretary: 

Since the Committee’s last meeting on February 4,1998, the economy has continued to perform qwte well. Indeed, 

the Commerce Department recently reported that GDP expanded at an impressive 4.2 prceat pace m the first 

quarter. To this poiat, consumer-led demand strength, gaius in cmstructicm activrty, and a rebound m businek 

capital spending have more than of&& any headwiuds in the trade sector arising from the financial crisis in Asia. 

While growth may moderate somewhat in 42, the underlying funws ofthe US. economy still appear quite 

supportive. Specifically, real Wosable personal income grow& is nmning at an above 4 percent clip an a 

yeadyear basis provldmg a good deal offuel for umtinued gains in domestic demand. 

On the mflation front, the news remains qrute favorable. A further decline m quates for energy products has 

copltributed to a deceleration in headline readings for both PPI and CPI, and, core price readings have remained 

benign. Meanwhile, despite tqht labor markets, wage pressures have been slow to build as reflected in the first 

quarter employment cost index report recently released by the Labor Department 

For the most part, fixed income markets have traded in a relatively M~OW range dunng the past few months with 

the yield cum slightly flatter than at the time ofthe Committee’s last meeting. This retlects a modest adjustment iu 

the marked’s assessment of the bre coufse of Federal Reserve policy. We the Fed is widely expected to leave 

policy unchanged m the near term, the market is naw priced fbr a small amount of ti@ming over the next several 

months in wntrast to the Man of very slight easing that was evident three months ago. 

Before considering recommeadations as to the composition of a financing to refimd $25.4 billion of privately held 

notes maturing on May 15, the Cammittee reviewed at leu@ alternatives fbr changes in Treasury market financing 

actiwty m light ofthe improvement m the Federal budget situation. 

In this regard, the Cammhtee wnsidered two langer-tem fmmcmg outlooks, one involving a codnuation of the 

currant size of net marketable debt paydown and the other reflecting a gradual decline m net debt paydowns. Ihe 

comrm#ee reviewed the impact these financing outlooks would have on the profile of Treasury bill and c~up~n 

issuance, the maavity composition of the autstandmg debt and the weighted average matwhy of the debt. T~IS 

began with an assumption based on the existing pattern and size of coupon offerings-with all size adjustments 

made in the bill market-and then extended to include reviewing the impact of various scetlafios for altering the 

size, composition and frequency of coupon offerings. 

In evaluating all the various scenarios, the C~mmr#ee * was oftbe view that the Treasury’s ImgerSenn interest 

would be best served by modtficatioars to the composition and fiequeacy of existing Treasury coupon &rings, 

rather than by continued downward adjustment to the sizes ofthose ofkings, as well as further cutbacks in bill 

issuance. Indeed, there was a strong consensus on the commr#ee ’ that tbe Treasury &odd shift its financing 

program m a fashion that would: 
2 

lurut further cantraction m net bill issuance by moving to gradually increase the size of regular bill 

offerings; 

0 cancentfate future net paydawns m the coupan sector; and 

6 refocus wupan ofkings around less frequent larger offerinss of benchmark Securities, to heIp preserve 

the attractive licpidrty fbtures of the Treasury coupain rnarket. 

To achieve these objectives, the Cammi#ee was unanimous in recormnending the fbllcnving changes to the existing 

coupon offering cycle: (1) elimination ofthe existing quarteriy offbrings of 3-year notes; (2) reducing the frequency 

of 5-year note ofhmgs from a monthly to a quarterly cycle replacing the 3-year note, witb each such quarterly 

&ring to be significantly larger than the current monthly issues; and (3) enlarging the remaining benchmark 

coupon of&riags, as opportunities permit, bahcmg the Treasury’s overall reduced issuance needs with the 

issuance capactty created by the elimination of 12 existing annual u)upo~1 offerings. 

In recammeabg these changes, the CommiUee filt that this would serve to enhance liquidrty m both the bill and 

coupon sectors of the market and restore the market focus on the Treasury’s quarterly refundqs. This was judged 

to be the most effective way to ensure the Treasury market’s status as the world’s most liquid capital market, 

particularly in light of changes m issuance patterns m ather goverriment debt markets. It would also facilitate 

effectrve Treasury cash management by increasing the relative size ofthe quarterly offermg cycles-tbus better 

matching interest and maturity coupon payments. 

As regards timing, the Ccmmtke was unanimously of the view that these changes should be introduced m the July- 

!kptember fiscal quarter. Specrfically, the Committee recommends discontinuing quarterly issuance of 3-year nates 

Nhviug the May refunding and discontinuing monthly issuance of 5-year nates fbllowing the June &ring. 

At the Treasury’s request, the Committee also discussed the possibiltty of changing the treatmeat of fbreign official 

account “add-ons” m current note and bond oflkrings, such that those amounts sold would, m the We, be 

mcluded within the announced amounts sold to the public-as they are now for the bill &rings-rather than 

added- to the size of the coupon ofWqs-as is the cutrent practice. Should such a change be made, it was 

noted that it would impact the maximum auction size awarded to any one bidder, thus necessitating the need for 

dsclosure of the amount of such awards prior to the day ofthe auction. It was suggested that procsdwraily this 

information was available to Treasury an the day Mre each auction, so it could presumably be disclosed Mre 

the auction. 

The Commitbe was almost evBoiy diwM m this issue, wrth ten members pre&rring dus change and nine members 

being opposed. Those m favor of the change feft that the Treasury could shift thls risk to the market, WI& the 

market able to make reasonable estimates of the size of these awards prior to the announcemeart of actual amounts 

one day before the auction. They also noted that the awards would be at market clearing prices fbr lower efktwe 

auction sizes, thus margmlly lowering costs to the Treasury. Finally, they &It there should be umsisteacy m 

treatment between coupon and bill o&rings. 

C‘ 

Those opposed felt this would fiuther reduce issue sizes m an ad hoc fbshm and was at odds with the desire to 

have large benchmark issues. They also < the announcemeut ofthe size ofthese awards after the cormrwncement 

of when-issued trading, but befbre the aucticm, could be dismve to the market. In effect, they felt the Treasury 

could better manage the risks of these awards as addons to their &rings by modestly adjusting announced issue 

sizes, than could the market, m adjusting to the new procedures. 
3 

In terms of timing of impldon, should such a procedural change be made, it was agreed that it should be no 

earlier than the start of the July-September quarter, to allow sufficient time to develop and implement new 

procedures fbr the dissemination ofneeded rnformatiaa to the market. Gwen the divided views an the merits ofthis 

fecommendations fix the current and next quaxter assume cmtkuation ofthe existing addon practice. 

change, and tbe uncertain timing for implemeatation were it to be impbnentd, the commrttee * 'sfinancing 

Finally, the Commi#ee briefly discussed the pWal for the use of buying back Treasury SBcurities from the 

secondary market. As noted m its last report, the Commi#ee %It that &us technique was potmtdly most useful to 

the Treasury when it was premature to consider changes in the number or fkquency of regular coupon &rings 

and when there was lunrted scqe fbr further redudians m existing issue sizes. In light of the extensive changes 

bemg recammended in the regular coupon &ring cyc1-d given wortunities to raise regular issue sizes as a 

result ofthose changes, the debt buyback tool would appdy have lunned usefihess to the Treasury at tfus time. 

That said, there may still be cirmces where the Treasury would find it advantageous to have such a 

capabilxty, although it was again noted that there wm some complex government acuxmtiq policy issues that 

would have to be addressed, were it to be utdked. 

Within this context, to refund $25.4 billion ofprivately&edd notes maturmg on May 15,1998 and to pay dawn $3.4 

billion of cash, the cMmt#ee ' recommends that the Treasury auctida $22.0 billion of the fouowtng securities: 

$10.0 billion 3-year nates due May 15,2001; 

0 $12.0 billion 10-year notes due May 15,2008; 

In its refunding recommendation, an 18-1 majority ofCommi#ee members %lt that the Treasury could reduce the 3- 

year note by $3.0 billion to the $10.0 billion level. The relatively small auction size was viewed as acceptable 

wdhm the overall recommendahan whch mcluded the elimination of 3-year notes m future fmancmg. The 

r-endation ofa $12.0 billion l0-year note reflects the cootinued desire of cwnrm#ee ' memberstoreinforce 

&IS sector with large issue sizes. 

The Commhtee recommends Treasury financing for the remamder of this quarter of the hllowing conp>osition: 

Two 2-year nutestotalmg $13.0 billion each and two 5-yearncih2s-g $11.0 billioneach, with these 

fouraudioospayingdownaw~of$l5.1 billion mcash; 

Two 1-year bills mhg $10.0 billion each, to pay down $9.1 billion of cash; 

c. 

Weekly issuance of3- and 6-moath bills through the remainder ofthe Wr, to pay down $10.7 billion of 

cash; and 

One cash management billtotalmg $15.0 billionto mr a cash low point in early June and mature during 

the quarter. 

This proposed financing schedule, as well as anticipated foreign add-ons of$7.7 billion, would result in a net 

paydown of $102 billion. "he Comrmttee ' believes strongly in the proposed schedule, and particularly the 
I 

4 

importance of a smooth transition m the 5-year sector with a June &ring marking the last ofthe mcmthly issues. 

This would limh the time gap befbre the first quarterly 5-year auction m August, and thus minimize any negatm 

impact on liquidrty in this sector. If, despite these considerations, the Treasury fblt it necessary to meet the $1 10 

billim paydown in the curreat quarter, the Cammittee would eliminate the June 5-year note, rather than Mer 

reduce other issue sizes. For the July-September 1998 quarter, the Treasury estimates a bommmg need of $0 to 

$5 billion, with a cash balance of $40 billion at the end of September. To acccxnplish ths requiremeat, the 

commt#ee recommends the attached provisional financing schedule, whch is at the low end ofTreasury eshates, 

m order to balance the proposal to have a somewhat smaller net paydown m the second quarter. 

In discussing the schedule for next quarter, the Chnutte ’ focused m the initial size fbr tbe first quarterly 5-year 

note and the appropriate sizes for the 2-year and l&pr rides in the quarter. A majorxty ofthe Committee 

members favored an $18 billion initial quarterly 5-year ride, while raising the two-year nates to $16 billion. A 

futther group of five members would pr&r a slightly smaller initial 5-year osring m order to Auther anlarge the 

10-year nate. A minority ofthree memben favorad an initial 5-year note ofS20 billion to maximize the -1 

liquidrty m that sector, given the cutback in the number ofof€erings. In turn, they would pr&r a somewhat smaller 

&year note. All members of the Committee rompzed that should the reammended new coupon &ring cycle be 

implemeuted, there would be ongoing opporhmities to judge and rebalance the issue sizes m light of both market 

experience and updated informaton on fhancmg needs. 

As a final matter, the Commhtee also discussed the appropriate maturity of the mflation-mdexed security to be 

auctioned m July. In this regard., the Gmmttee was nearly unaaimous m the view that it should be a reopening of 

the recently issued 30-year security. We recognizing that the program was still m dedopmdal stages, there 

was a stroag sense that the 30-year issue had received solid underlying market interest, especially m winparison to 

the 5-year offerings, and that it would be m the Treasury’s interest to fUrther develop the 1ang-d ofthis market, 

smce that is where there is most demand for inflation protection. En makmg this recommenclat.m, the Committee 

felt that this would not prejudge when to move to a regular cycle of mflation-indexed offerings and what that cycle 

should be. 

Stephen G. Thieke 

chairman