Treasury Borrowing Advisory Committee Presenta

• At the November 2015 Quarterly Refunding, and consistent with a recommendatio

Committee, Treasury reaffirmed its commitment to increase Treasury bill issuance

declining deficits, Treasury’s borrowing needs have declined over the last several order to increase Treasury bill issuance meaningfully, Treasury may need to reduc

coupon or TIPS issuance over the next year or two.

• We would like the Committee to discuss the appropriate size of an increase in bill 

over the next couple of years. If a reduction in nominal coupon and TIPS issuance required, discuss how Treasury should evaluate issuance across these securities

should be considered and how should they be weighed against each other?

1
Agenda

Bills supply and demand dynamics

• What are the drivers of demand for HQLA?

• What are the supply dynamics for Tbills/HQLA? 

• How substitutable are various short How substitutable are various short-end products? end products?

Given these demand dynamics, how much should TBill supply be increased?

• Are there any particular tenors of T-Bills that should be the focus of increases?• Should Treasury consider adding an additional T Should Treasury consider adding an additional T-bill tenor ( bill tenor (e.g, 2 month)? , 2 month)?

Treasury financing needs

• What is the deficit/net borrowing needs outlook through the end of FY2017?

• With the existing auction sizes, is Treasury over financed or underfinanced? By how mu

• What is the likelihood that the Federal Reserve will begin to reduce the SOMA portfolio • What are the estimates for the magnitude of the reductions through FY2017?• To what extent should Treasury reduce coupon or TIPS issuance in order to increase b

Framework for determining how to reduce coupon and TIPS issuance?

• What sort of framework(s)/factors should Treasury consider for evaluating where to red

• How should Treasury implement any such reductions in coupons and/or TIPS? How should Treasury implement any such reductions in coupons and/or TIPS?• If Treasury should reduce TIPS issuance, how should Treasury communicate the fact th

committed to the TIPS program?

2
Bills supply and demand dynamics

3
A supply imbalance will develop for government sa

Est. imbalance for short term safe assets ($bn)

• We expect the demand for 

assets to exceed the availab

and 2017

2016 2017

Demand for safe ST assetsG l f db l 300 100 and 2017

• The Treasury can fill the ga

bill issuance

Gov-only money fun

d

b

alances 300 100

Bank deposit outflows 150 0Other demand (HQLA, margin) 50 50Total 500 150Supply of safe Supply of safe ST assets ST assetsPrivate sector repo -90 -90FHLB issuance 75 25RRP usage 285 150Total 270 85 • Even if the Treasury increases Projected supply imbalance -230 -65 by $230bn there may not be 

bill rates given the equally st

• The bill-OIS spread may 

-10bp to-15bp level

Bill-OIS, 3m (bp)

0 10bp to 15bp level

• Additional issuance in 2017 w

cheapen bills 

• In 2013, when the bill/to

-10

-5

0

at 13%, 3m bills traded 

-25

-20

-15

A 09

A 11

A 13

A 15

4

Source: US Treasu

Apr-09

Apr-11

Apr-13

Apr-15
Factors affecting bills on the demand side (1)

Institutional prime fund departures in 2016• Institutional prime fund investors are likely to start leaving next year 

ahead of the October 2016 mandatory money fund reform deadline

• The 

pace and scale of the de

partures will de

pend on:

Prime fun

1,400

1,450

p pp

• Level of market rates 

• Are prime fund returns high enough to overcome investor 

dislike of floating NAVs, liquidity fees, and redemption gates? 1,300

1,350

1,400

• How aggressively will the Fed raise interest rates?

• Availability of substitutes – such as bank deposits and gov-only 

money funds

• Lar

ge US banks face ca

pital and de

posit insurance 

1,200

1,250

Jan-15 Apr-15 

g pp

assessments that make them unwilling deposit recipients

• We have little sense of how much money will leave institutional 

prime funds next year but our initial estimate is $300bn

Gov-onl

375

425

Gov-only money fund portfolio reallocation• If $300bn leaves prime funds for gov-only funds in the first half of 2016 

the demand for gov-safe assets could rise sharply

• Based on current 

gov-onl

y fund allocations: 225

275

325

g

y

• Tsys +$105bn, Agencies +$85bn, Gov-repo +$111bn

• But if agency and private sector gov-repo is less available, govonly funds could ramp up their Treasury allocations

175

Jan-12 Jan-13 

AGY 

5 

• To 50% or more from 35% currently
Factors affecting bills on the demand side (2)

Other sources of demand• Large US banks are eager to shed non-operating deposits as these 

balances are expensive for the banks to maintain

• A shortage of safe assets for them to deploy these cash balances

Money fun

107

108

A shortage of safe assets for them to deploy these cash balances

• Deposit insurance assessments are determined by the total sum of 

the banks’ assets 

• Likewise the supplemental leverage ratio is determined by total 

t ( ith t d t i k i hti ) l it l

104

105

106

assets (without regar

d to ris

k weighting) less capit

al

• One large bank has already shed $200bn in non-operating balances in 

2015 (after announcing plans to shed $100bn in February 2015)

• There are few places for this cash to go beside government-only 100

101102103

money funds

97

9899

0 2 

Money fund balances typically increase in a tightening Months • Traditionally, bank de

posit rates la

g the increase in the fed funds rate 

Total MMF 

y, p g

during a tightening

• And deposits flow into money funds

• In past rate hike cycles, money fund balances have risen an average of 

7% in the year after the first hike

Note: Money fund balanof the tightening cycle. 

7% and 2004 cycles. Sourc

in the year after the first hike

• But the increase may be larger as banks are eager to shed 

balances given capital and deposit insurance costs

and 2004 cycles. Sourc

Research

6 Sourc
Factors affecting bills on the supply side (1)

• Less competition from private sector TSY repo

• Bank capital requirements become more binding

Declining dealer Treasu

2,000

2,100

Bank capital requirements become more binding

• More institutions shift to average daily net exposure reporting

• effectively makes “every day a quarter-end”

• We expect Treasury tri-party repo volumes to shrink by 20% 1,700

1,800

1,900

(or $180bn) through 2017

• Although this is conservative given the behavior of the 

GCF market on quarter-ends where the decline is closer to 40%

1,5001,600

10 11 12 

• FHLB discount note issuance to slow

• Recent sur

ge driven b

y demand for advances from a handful of 

500

Discount notes 

g y

large US banks (FHLB advances used to purchase HQLA)

• FHLB discount note issuance has picked up sharply as 

other GSEs have stepped back from issuing disc notes

• But in 2015 bank demand for FHLB advances began to cool as 100

200300

400

• But in 2015, bank demand for FHLB advances began to cool as

the largest banks are already LCR-compliant

0

100

10 11 12 

FNMA 

7

1/ Includes bilate
Factors affecting bills on the supply side (2)

• More collateral from the Fed’s RRP

• Close, but not perfect, substitute for Treasury bills

• Not all cash-long institutions have access to the RRP

Daily overnight 

400500

• Small money funds (under $5bn in AUM), nonmoney market asset managers, securities lenders

• The Fed is likely uncomfortable with an unlimited RRP program 

given its 

potential to dis-intermediate bank financin

g in a crisis

200300

400

g p

g

• We expect a cap will be re-imposed on the RRP – perhaps 

as early as Jun’16, and then steadily reduced through ‘17

0

100

Jun-15 Aug-15 

RRP use has been moderate since lift-off• The volume of extra collateral provided by the RRP depends on the 

spread between market interest rates and the RRP and dealer balance 

h t it

Tsy triparty repo rate ha

than 

70

bp

s

hee

t capacit

y

• Treasury tri-party repo rates have averaged 4bp above the RRP 

since lift-off 

• And this has been sufficient to keep daily program usage 30

405060

fairly moderate

• Outside of the balance sheet driven surge at year-end 

average post-lift off usage has been $160bn/day 0

1020

Jan-15 Mar-15 May-15 Jul

8

Source: Fe

BNY ex RRP 
A new bill maturity?

• An increase in bill issuance of $230bn in 2016 might justify the introduction of a n

• Balance sheet constraints make it more difficult for the primary dealers to bi

Should Treasury consider adding an additional T-bill tenor (e.g, 2 month)?

Balance sheet constraints make it more difficult for the primary dealers to bi

rata shares of super-sized bill auctions

• Market participants seem interested in a 2m maturity

• Other suggestions have included bills with of less than 1m to mat

Other suggestions have included bills with of less than 1m to mat

• Or changing the settlement cycle so that some weekly bills settle o

than Thursday

• But it is not clear how either would benefit the Treasury

• Investors are somewhat familiar with the 2m maturity from the Treasur

Supplemental Financing Bill program

• If the Treasury decides to introduce a new bill maturity we expect the m

would be for a 2m security

9
Treasury financing needs and issuance outlook

10
Budget deficits are likely to be higher going for

What is the deficit/net borrowing needs outlook through the end of FY2017?

• Budget deficits have been shrinking over the last few years amid solid tax revenu

seem to have stabilized recentl

yg y as 

growth of outla

ys has increased

• Budget deficits expected to widen going forward amid a modest slowdown in rev

a pickup in outlays. We expect budget deficits of ~$550bn in FY16 and FY17.

• The increase is largely a result of the Bipartisan Budget Act of 2015, a retroactive 

Budget Deficit Outlook

provisions calendar effects. More broadly, entitlement related outlays will continu

$400

$0$400

10%20%30% Deficit FY'15: $439bn Revenue growth: 7.6%

Outlay growth: 5.2%

Barclays Forecast

Revenue 

Growth, 

y/y

-$1,200

-$800-$400

-10%

0%

10% y/y 

FY'14 8.9% FY'15 7.6% FY'16 3.9% FY'17 4.5% 

-20% -$1,600

01 03 05 07 09 11 13 15

Receipts, y/y % Outlays, y/y % 12m deficit (RHS, $bn)

11

Source: Hav
Borrowing needs likely to remain higher than d

What is the deficit/net borrowing needs outlook through the end of FY2017?

• Borrowing needs are likely to be higher than budget deficits owing to changes i

other financin

g ,p y needs, particularl

y student loans

• Expect Borrowing needs of roughly $725bn in FY16 and $625bn in FY17

Net Borrowing Need Projection Projection for cash balan

financing p

700 Projection $bn400500600

$bn

FY2015 FY2016 FY2017

Deficit (Barcla

ys Estimate) 439 550 550

+ Increase in o

peratin

g cash balance 40 100 0

Starting Cash Balance 158 199 300

Projection

100200300 Starting Cash Balance 158 199 300 Endin

g Cash Balance 199 300 300

+Other financing needs (inc student loan 

pro

gram) 79 75 75

Net Borrowin

g Need 558 725 625

-100

0

05 06 07 08 09 10 11 

Level of Operating 12m chan

ge in stud

12

Source: Hav

g 
The Treasury is underfinanced through FY201

With the existing auction sizes, is Treasury over financed or underfinanced now and then end of FY2017?

Scenario 1: The Fed continues to reinvest the entire maturing amount of Treasuries

$bn FY2015 FY2016 FY2017Gross to Pvt Investors (ex-bills) (A) $ 2,131 $ 2,119 $ 2,119 

Fed Add-ons (B) $ 3 $ 174 $ 192 Total Gross Issuance (C=A+B) $ 2,134 $ 2,293 $ 2,311 

b ( b ll ) ( )

$

$

$

Scenario 1: The Fed continues to reinvest the entire maturing amount of Treasuries

With existing coupunderfinanced by ~

Maturin

g De

bt (exbills) (D) $ 1,523 

$ 1,738 

$ 1,867 $180bn in FY17

Net Issuance (ex-bills) (E=C-D) $ 611 $ 555 $ 444 

Borrowing Needs (F) $ 558 $ 725 $ 625 Fundin

g

g

ap (F-E, +ve shows underfunding) $ (53) $ 170 $ 181 

Bills, % of outstanding 10.6% 11.3% 12.0%

$180bn in FY17

Bills, as % of outsta

$b 201 2016 201

Scenario 2: The Fed maintains reinvestment policy in FY2016, but tapers reinvestments gradually star

$bn FY2015 FY2016 FY201

7

Gross to Pvt Investors (ex-bills) (A) $ 2,131 $ 2,119 $ 2,119 

Fed Add-ons (B) $ 3 $ 174 $ 164 Total Gross Issuance (C=A+B) $ 2,134 $ 2,293 $ 2,283 Maturin

g Debt (ex-bills) (D) $ 1,523 $ 1,738 $ 1,867 

With existing coupounderfinanced by ~$Bills, as % of outstan

Net Issuance (ex-bills) (E=C-D) $ 611 $ 555 $ 416 

Borrowing Needs (F) $ 558 $ 725 $ 625 Fundin

g

g

ap (F-E, +ve shows underfunding) $ (53) $ 170 $ 209 

Bills, % of outstanding 10.6% 11.3% 12.2%

By FY’18, bills will be 

13

Source: Hav
SOMA Reinvestments: Likely to remain in place 

What is the likelihood that the Federal Reserve will begin to reduce the SOMA portfolio between NY Fed President Dudley (Jan’16): “If the economy were growing very quickly and the risks of an early return to th

FOMC statement Dec’15: The Committee ... anticipates [reinvesting] until normalization of the level of the federa

NY Fed President Dudley (Jan 16): If the economy were growing very quickly and the risks of an early return to th

federal funds rate were deemed to be low, then I could see ending reinvestment at a relatively low federal funds raeconomy lacked forward momentum and the risks of a return to the zero lower bound were judged to be considercontinue reinvestment until the federal funds rate was higher.”

Low unemployment rate, modestly above trend GDP growth and rising core inflaallow the FOMC to begin phasing out reinvestments around Q1’17

Median Consensus Forecast 2015 2016 2017%

Q1 Q

2

Q

3

Q

4

Q1 

Consensus Forecasts

Q

Q

Q

Q

Q

Real GDP (q/q saar) 2.0* 2.5 2.6 2.5 2.5 2.3 Private consumption (q/q saar) 2.7* 2.8 2.8 2.7 2.6 2.4Unemployment rate 5.0 4.9 4.8 4.8 4.7 4.7 Core PCE (y/y) 1.3 1.5 1.5 1.6 1.7 1.8 Fed Funds rate (upper end) 0.50 0.75 0.75 1.00 1.25 1.50 * Assuming consensus forecast of 1.4% and 2.3% in Q4 for real GDP and Private Consumptio

14

Sourc
Consensus for reinvestment phase out to begin 

and last 12 months

What is the likelihood that the Federal Reserve will begin to reduce the SOMA portfolio between 

NY Fed Survey suggests Q1 17 as the start of ending reinvestments or NY Fed Survey suggests Q1 17 as the start of ending reinvestments, or

~15m after the first hike 15m after the first hike

Most likely time for Fed to first cease reinvesting Number of months relative to liftoff

Treasuries Agency Debt and MBS Treasuries 

25th percentile response Q1'17 Q4'16 25th percentile response 12 Median response Q1'17 Q1'17 Median response 15 75th percentile response Q2'17 Q1'17 75th percentile response 18 

Probability of phase-out process for reinvestments in Treasuries

No change to Reinvestments Reinvestments phased

NY Fed Survey suggests a 65% chance that reinvestments will be phased out - on average over 12m

Anticipated duration of phase-out (mth

No change to 25th til

8

reinvestments

Reinvestments

ceased all at once

Reinvestments phased

out over time

Average 19% 18% 64%

25th percentile response 8Median response 1275th percentile response 12

15
SOMA portfolio is unlikely to be materially reduce

If the Fed decides to reduce the SOMA portfolio, what are the estimates for magnitude of the re

5060 Monthly amount reinvested, $

SOMA portfolio should shrink by $29bn by FY 17 and 

$375bn by FY 18 assuming gradual phase out

10203040

Amt reinvested from maturing Tsy in SOMA

0

Sep-15 Mar-16 Sep-16 Mar-17 

No ending of reinvestmeEnding reinvestment graE di i t t i M 

Amt reinvested frommaturing Tsy inSOMA$bn No ending of reinvestment

Ending 

reinvestment 

gradually starting 

Q1'17

Ending 

reinvestment in 

Mar'17

FY2016 174 174 174 Ending reinvestment in 

M

$

-100

0

Reduction in amount reinvested

FY2016 174 174 174FY2017 192 164 73Total 366 338 247Cumulative Chan

ge

-29 -119

$(119)

-500-400-300-200

g

-600

Sep-16 Mar-17 Sep-17 

No ending of reinvestmenEnding reinvestment gradEnding reinvestment in M

16

Source: Hav

Ending reinvestment in M
Room for cuts in coupon sizes

• Bill issuance to fall short of ex-ante demand in 2016 by ~$50-75bn. • We recommend that the Treasury cut auction sizes to allow for a faster expansion of the bill un• Extent of cuts should also take into account future funding gaps. Deeper cuts now would sig

funding gap in future years funding gap in future years

• For instance, if the Treasury cuts all coupon sizes by just $1bn each starting February, funding g

$295bn in addition to roughly $225bn in FY 16.

• While $225bn in net bill issuance is likely to be easily absorbed in FY 16, another $295bn in FY 

• The Treasury could also temporarily increase the cash balance in FY 16 to allow for a greater ex

universe in the near term without having to rely on cutting coupon auction sizes

• Where should the Treasury reduce auction sizes? 

2016 2017

Demand for safe ST assets

Est. imbalance for short term safe assets ($bn) Tsy overfinancing under scenario of Fed 

$bn 

Demand Gross to Pvt Investors (ex-bills) (A) $ 

for safe ST assets

Gov-only money fund balances 300 100Bank deposit outflows 150 0Other demand (HQLA, margin) 50 50Total 500 150Supply of safe ST assets

( )( )

Fed Add-ons (B) $ 

Total Gross Issuance (C=A+B) $ Maturin

g Debt (ex-bills) (D) $ 

Net Issuance (ex-bills) (E=C-D) $ Borrowing Needs (F) $ 

pp y

Private sector repo -90 -90FHLB issuance 75 25RRP usage 285 150Total 270 85Projected supply imbalance -230 -65

Fundin

g

g

ap (F-E, +ve shows underfunding) $ 

Bills, % of outstanding 

17

Source: Hav
Ex-ante cost of issuing debt is highest at the lo

• Even though term premium has declined recently and is currently close to zero, the shape o

curve remains upward sloping

• Ex-ante cost of issuing long term debt is higher than issuing short term debt

While term premium has declined...

1.21.4 Term structure of Term Pre

...term structure of term premium 

3.504.00

0 40.60.81.01.2

1.502.002.503.00

0 4

-0.2

0.00.2

0.4

-0.50

0.000.501.00

-0.4

1y 2y 3y 4y 5y 6y 

Pre-crisis avg (1997-2007) 

-1.00

90 92 94 96 98 00 02 04 06 08 10 12 14

10y Term Premium, %

18

Source: Hav
Long end is trading significantly cheap relative t

• In sharp contrast to a few years ago, long end Treasuries are trading significantly cheap to O• This cheapening has happened throughout 2015 and seems persistent. • This increases the ex This increases the ex-ante cost of issuing long term debt ante cost of issuing long term debt

Long end Treasuries cheap to OIS

77 80

100 bp

30y Tsy have cheapened to OIS 

4 04.5

%

21 25 21 29 20

36 

45 43 

4060

80

2 02.53.03.54.0

(3)

10 

21 21

(15)

20

-20

0

20

0 00.51.01.52.0

(15) 3m bills 2s 5s 7s 10s 30s

Jan-14 Jan-16

0.0

12 13 14 

30y OIS 30y Tsy yield 

19
WAM is already close to the historical highs

WAM is already at multi-dec

outstanding in bills is c

• WAM of the Treasury universe has already risen to the highs. •% maturing at the very long end has steadily risen over th l t f 70

75 mths

the las

t

few years. 

•% bills is close to the historical lows•These alon

g with u

pward slo

pin

g term 

premia suggest 50

55606570

% of debt maturing in 20y+ has already 

risen back to the 2000 hi

ghs

g p pg

p gg

room for long end sizes to be reduced

404550

80 85 90 95 00 

Average Maturity, mon

g $2 auction size cut from 

42% 40%

50% % of outstanding

$2 auction size cut from $1 auction size cut from 

35%40%45%50%

26%

20% 20%30%

10%15%20%25%30%35%

2%

11%

0%

10%

01 03 05 07 09 11 13 15

<1y 1 5y

5 10y 10 20y 20y+

0%5%

55 60 65 70 75 80 85 90 

Bills, % of marketab$1 auction size cut f$2 auction size cut f

20

Source: Hav

<1y 1-5y

5-10y 10-20y 20y+ $2 auction size cut f
Deep cuts in auction size of any tenor should b

The Treasury should maintain a certain buffer versus the minimum size needed to maintain 

28

35

29 30

3540

21 20

28

23

18

26

24 24

16

18

15 

202530

11

13

10

6

15

9

5

1015

0

2y 3y 5y 7y 10y 30y 5y TIPS 10y TIPS30y TIPS 2

Minimum Auction Size needed to maintain Benchmark Liquidity Minimum Auction Size needed to maintain Benchmark Liquidity Current Current

21

Source: U
The Treasury could also rely on a higher cash bala

expand the T-bill universe in a short order

• To increase bill issuance significantly in 2016 without aggressively cutting coupon iss

could also increase its year-end cash buffer 

• TBAC recommendation was to maintain $500bn in cash balance for 10d of li

q y uidit

y. Y

was $333bn. 

The Treasury could also target a higher cash balance Higher cash balance would res

300

350

400

-10

-5

05

150

200

250

-30-25-20-15

0

50

100

Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16

-40-35

11 12 13 

3m bill - IOER 

22

Jan-14 May-14 Sep-14 Jan-15 May-15 Sep-15 Jan-16
The Treasury should also consider reducing TIP

•The Treasury should also consider reducing TIPS issuance, along with nominals coupon Treasu•TIPS’ share of net coupon issuance would rise to about 17% and TIPS current share of the outs

would also rise from about 10.3% to 10.6% by year-end. 

•It h ld t i TIPS l ti t i l l ti h t t l d 

It s

hould no

t increase TIPS relative 

to nominal coupon supply as a time w

hen s

truc

tural deman

class may have declined. 

•Foreign official institutions may have reached a steady state in their TIPS holdings as a pereserves. Risk-parity funds, a historically important TIPS demand base, may also be less ke

class because

of its in

crease volatility

a

n

d corr

elation 

of brea

keven perform

a

nce

with ri

sk 

Inflation risk 

premium is likel

y now ne

gative and illi

quidit

y discount has remained 

per

c ass ecause o ts c ease vo at ty a d co e at o o ea eve pe o a ce w t s 

•It appears that inflation risk premium is much lower now where as illiquidity discount has remasuggesting a greater cost in issuing TIPS relative to Nominals.

p y g qy p

3.03.23.4

%

4550

bp

2.42.62.8

2025303540

2.02.2

Mar-06 Mar-08 Mar-10 Mar-12 Mar-14

5

y

5

y CPI Inflation Ex

pectation, SPF

5

y

5

y CPI Swa

p Rate

101520

12 13 14 

10Y TIPS Relative AS

23

Source: Hav

yy p , yy p
Implementation / Communication strategy

• Overall, the Treasury should consider making modest cuts to coupon auction sizes. • Long end of the nominal curve and TIPS appear to be the best candidates for making modest • Were the Treasury to pursue much deeper cuts, they should be spread across all tenors to ma

minimum size needed for liquidity minimum size needed for liquidity

• The Treasury should gradually reduce auction sizes maintaining its policy of being regular and • Specifically with respect to TIPS, the Treasury should emphasise commitment to the program

• It should stress that reduction in TIPS auction sizes is in line with the overall policy of red

It should stress that reduction in TIPS auction sizes is in line with the overall policy of red

make way for T-bills. 

• Highlight that from the peak, reduction in nominal coupon sizes is still larger than that f• Note that TIPS auction sizes may very well be raised again if coupon auction sizes are ra

• The Treasury should increase the frequency of new issue 5y TIPS auctions

• The Treasury should issue the same, or slightly lower, annual amount but across two cusi

where one would mature in April and the other in October where one would mature in April and the other in October. 

• This would add another maturity seasonal point to the curve; this would help the inflation Treasury should point to this as an example of greater commitment to the inflation market

• Th T ld b i h h l i i hi h ill 

The 

Treasury would save 

borrowing costs t

hroug

h a lower auction concession whi

c

h will 

sizes. • Most April issues trade cheap because of their large size. The large size of the April series 

pressure on them when they roll out of 1-30y TIPS indices

24

pressure on them when they roll out of 1 30y TIPS indices