Presentation to the 

Treasury Borrowing Advisory Committee

U.S. Department o

Offi f D bOffice of Deb

A
The fiscal deficit year to date reached nearly $1.1 trillion in J

-1200 

$ Billions

Fiscal Year to Date Deficits

(monthly data) 

-9

-1000

2007 Y-O-Y % Change

2008 2009

-483

-455

485

-569

-765

-800-600

-258

-274 -263

-311 -319

-269

-371

483

-237

-402

-485

-400

-49

-122

-80

-42

-162

-81

-148

-121

-157 -163

-56

-154

-106-88

-152

237

-200

0

Office of Debt Management

Oct-06

Nov-06

Dec-06

Jan-07

Feb-07

Mar-07

Apr-07

May-07

Jun-07

Jul-07

Aug-07

Sep-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09
After briefly stabilizing during the tax season, the budget de

to grow

Oct. Nov. Dec. Jan. Feb. Mar. A

pr. Ma

y Jun. Jul. Au

g. 

Cumulative Budget Deficit by Month

FY 2009 v. Previous Years

2004 2005 2006 2007 2008 2009

($200)

$0 

p

y

g

($800)($600)($400)

ns

($1 200)($1,000)

($800)

$ Billion

($1 600)($1,400)($1,200)

Office of Debt Management

($1,600)
In the third quarter of FY2009, year-over-year growth in rece

negative while outlay growth accelerated

R it

25003000

Receipts

FY07 FY08 FY09 OMB 5/09 Guidance Proj (Smoothed)

100015002000

$ Bil.

0

500

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug 

Outlays

-500

0

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug 

FY07 FY08 FY09 OMB 5/09 Guidance Proj (Smoothed)

-2500-2000-1500-1000

$ Bil.

Office of Debt Management

-4500-4000-3500-3000
Non-Withheld and Corporate Income Taxes led receipt declin

over-year basis

300350400

Corporate Income Tax

FY07 FY08 FY09

125015001750

Withheld Individu

FY06 FY07 

150200250300

$ Bill

500750

1000

1250

$ Bill

0

50

100

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug

0

250

500

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 1

-50

0

Tax Refunds

FY06 FY07 F

500600

Non-Withheld Individual Tax

FY06 FY07 FY08 FY09

-300-250-200-150-100

$ Bill

200300400

$ Bill

Office of Debt Management

-450-400-350

300

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17

0

100

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug
Tax receipts continued to decline in the last quarter with wit

potentially lagging other categories

30%40%

Rolling 12-Month Growth Rates

Corp TaxesWH TaxesnWH Taxes

20%

0%

10%

-20%-10%

40%

-30%

Office of Debt Management

-

Mar-82

Jul-82

Nov-82

Mar-83

Jul-83

Nov-83

Mar-84

Jul-84

Nov-84

Mar-85

Jul-85

Nov-85

Mar-86

Jul-86

Nov-86

Mar-87

Jul-87

Nov-87

Mar-88

Jul-88

Nov-88

Mar-89

Jul-89

Nov-89

Mar-90

Jul-90

Nov-90

Mar-91

Jul-91

Nov-91

Mar-92

Jul-92

Nov-92

Mar-93

Jul-93

Nov-93

Mar-94

Jul-94

Nov-94

Mar-95

Jul-95

Nov-95

Mar-96

Jul-96

Nov-96

Mar-97

Jul-97

Nov-97

Mar-98

Jul-98

Nov-98

Mar-99

Jul-99

Nov-99

Mar-00

Jul-00

Nov-00

Mar-01

Jul-01

Nov-01

Mar-02

Jul-02

Nov-02

Mar-03

Jul-03

Nov-03

Mar-04

Jl04
Education and Medicaid expenditures drove increases in ou

over-year

-50

0

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug

Defense Vendors

FY07 FY08 FY09

-25

0

1-Oct 15-Nov31-Dec 15-Feb 1-Apr 1

Education

FY07 FY08 

-250-200-150-100

$ Bill

-100

-75-50-25

$ Bill

M di id

-400-350-300

M di

-150-125-100

0

1-Oct 15-Nov31-Dec15-Feb 1-Apr 17

M

edicaid

FY07 FY08 

-50

0

1-Oct 15-Nov 31-Dec 15-Feb 1-Apr 17-May 2-Jul 16-Aug

M

edicare

FY07 FY08 FY09

-150-100

-50

$ Bill -300 -250

-200-150-100

$ Bill

Office of Debt Management

-250-200

-500-450-400-350
Net interest on debt has declined while other outlay categori

increased

Budget Totals Through June: Outlays

(Billions of Dollars)

FY 2007 FY 2008 FY 

SourceDefense-Military $397 $440 Social Security Benefits Social Security Benefits 438 461 Medicare 339 337 Medicaid 144 151 Unemployment Benefits 28 32 Other 459 607 

Subtotal 1,805 2,028 2

Net interest on Debt 261 191 

TARP 0 0 Payments to GSEs 0 0 

Total 2,066 2,220 2

(P t f Wh l Y ) 76% 75%

Office of Debt Management

(P

ct of Wh

ole 

Year) 76% 75%
Cash balances remain elevated as a result of SFP rollovers

125150175

$ billions

Treasury Daily Operating Cash Balance

Excluding SFPs

FY 2007 FY 2008 FY 2009 Note: D

Dec. 15 Apr. 15 Jun. 15

5075

100

125

0

25

Oct Nov Dec Jan Feb Mar Apr May Jun Jul 

Daily Treasury Operating Cash Balances

500600700800

$ billions Daily Treasury Operating Cash Balances Note: Data t

Cash Balance with SFPs

100200300400500

Cash Balance without SFPs

Office of Debt Management

0

100

Jul-08 Aug-08 Sep-08 Oct-08 Nov-08 Dec-08 Jan-09 Feb-09 Mar-09 Apr-09 May-0
Treasury has responded to these financing needs in a regula

predictable manner

Financing Net Flows since FY 2007

SFP Amounts CMBs Reg Bills TIPS Notes Bonds Deficit

FY 2009 Deficit as of 7/1/2009

= 

FY 2007 Deficit

= $162b

FY 2008 Deficit

= $455b

t-06

n-07

r-07

l-07

t-07

n-08

r-08

l-08

t-08

n-09

Office of Debt Management

Oct

Jan

Apr

Jul

Oct

Jan

Apr

Jul

Oct

Jan

FY 2007 FY 2008 
The lag between obligations and cash outlays by the Recove

increase marketable borrowing in late FY2009 and early FY2

180200

$Billions Stimulus Cash Outlays versus Obligations

140160

Obli

gated/Contracted 

80

100120

g

Cash Outlays

4060

0

20

009

009

009

009

009

009

009

009

009

009

009

009

009

009

009

009

Office of Debt Management

3/7/2

3/14/2

3/21/2

3/28/2

4/4/2

4/11/2

4/18/2

4/25/2

5/2/2

5/9/2

5/16/2

5/23/2

5/30/2

6/6/2

6/13/2

6/20/2

Source: 
Bill issuance levels remain elevated; SFP rollovers continue

CMBs and SFP Out

(as of 7/31/0

CMBs SFPs

1 2001,4001,6001,800

Outstanding Weekly Bills FY05-FY09

Priv Bills SOMA Total

In Billions ($)

400600800

1,000

1,200

10/1/07 1/1/08 4/1/08 7/1/08 10/1/08 

0200400

Oct-05 Apr-06 Nov-06 May-07 Dec-07 Jun-08 Jan-09 Aug-09 Feb-10

$100$110$120

Total Bills Maturing In Billions ($)

1 2001,4001,6001,800

Billions Cumulative CMBs Issued in a Fiscal Year

FY09 FY08 FY07 FY06

$70$80$90

$100

400600800

1,000

1,200

Office of Debt Management

$60$70

Jun-08 Aug-08 Oct-08 Dec-08 Feb-0

0

200

10/1 11/1 12/1 1/1 2/1 3/1 4/1 5/1 6/1 7/1 8/1 9/1
To extend the average maturity, nominal coupon issuance h

higher than in previous years

FY09 

$1,200

In Billions Net Total Coupons Issued

$800

$1,000

$600$200$400

$0

Office of Debt Management

-$200

10/1 12/30 3/29 6/27 
Existing coupon securities continue to increase to larger, m

benchmark sizes in a gradual, predictable manner

5560

Coupon Issuance in 2007-2009

45503540

Size (billions, $)

202530

S

3-Year (Monthly)

101520

30-Year

(rolling total of last 3 months)

Office of Debt Management

Sept-07

Oct-07

Nov-07

Dec-07

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sept-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09
DV01 has increased gradually as auction sizes increase

100120

01 

alents)

Billions

Changing DV01 Risk by Month

(10-Year Equivalents)

2-Year Nominal 3-Year Nominal 5-Year Nominal 7-Year Nominal 10-Year Nominal30-Year Nominal

5-Year TIPS 10-Year TIPS 20-Year TIPS Grand Total

20406080

Issuance DV0

$, 10-Year Equiva30 Year Nominal

5 Year TIPS 10 Year TIPS 20 Year TIPS Grand Total

Weekl

y Avera

ge DV01 of Cou

pon Auctions

0

Jan-08

Feb-08

Mar-08

Apr-08

May-08

Jun-08

Jul-08

Aug-08

Sep-08

Oct-08

Nov-08

Dec-08

Jan-09

Feb-09

Mar-09

($

506070

Billions

y g

p

(10-Year Equivalents)

10203040

Office of Debt Management

0

1/1/2007

2/1/2007

3/1/2007

4/1/2007

5/1/2007

6/1/2007

7/1/2007

8/1/2007

9/1/2007

10/1/2007

11/1/2007

12/1/2007

1/1/2008

2/1/2008

3/1/2008

4/1/2008

5/1/2008

6/1/2008

7/1/2008

8/1/2008

9/1/2008

10/1/2008

11/1/2008

12/1/2008

1/1/2009
Maturing 2-year, 3-year and 5-year notes will lead to increase

medium-term financing needs

C *

7080

$ Billions

Coupons Maturing*

August 15, 2009-May 15, 2039

2 YR NOTE 3 YR NOTE 5 YR NOTE 10 YR NOTE 30 YR BOND7 YR NOTE 5 YR IIS NOTE 10 YR IIS NOTE 20 YR IIS BOND 30 YR IIS BON

*Based on coupon securities ou

6070

In the next 5 years, 67 days will have maturities greater than $20 billion and 38 days greater than $30 billion.

4050203010

Office of Debt Management

0

15-AUG-2009

15-NOV-2009

15-FEB-2010

15-MAY-2010

15-AUG-2010

15-NOV-2010

15-FEB-2011

30-JUN-2011

15-NOV-2011

15-FEB-2012

15-MAY-2012

15-AUG-2012

31-DEC-2012

30-APR-2013

15-AUG-2013

31-DEC-2013

15-APR-2014

15-AUG-2014

15-AUG-2015

30-APR-2016

15-NOV-2016

15-NOV-2017

15-NOV-2018

15-FEB-2020

15-NOV-2021
The average maturity of the marketable debt outstanding inc

third quarter of FY 2009 as short-term issuance stabilized

90 

months Debt Maturity Measures 

80 

Average Maturity 

607050 

Average Maturity of Marketable Debt Outstandin

g

c

3040

g

1 Actuals use a 4-

quarter average. 

Office of Debt Management

20 

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 

q g

Data through June 30, 2009. 
The share of medium term notes outstanding has increased 

expense of other maturities

Di t ib ti f M k t bl D bt O t t di b S it

45%50%

Di

strib

ution of Mar

k

etable 

D

ebt

O

utstanding 

by 

Securit

y

Fiscal Year 

35%40%45%

BILLS 2-3 YR NOTES 4-7 YR NOTES 8-10 YR NOTES BONDS 

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

5%

10%

Office of Debt Management

0% 

1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 200
Primary dealer estimates for the FY 2009 deficit shrunk by $1

from the estimate provided during the May 2009 refunding

FY 09 Deficit Estimates FY 09 Deficit Estimates 

Primary Dealers* CBO 

Current: 1644 1825 Range based on average absolute forecast error** 1605-1683 1772-1878 

Estimates as of: July 09 June 09 FY 2009 Marketable Borrowing Range*** 1500-2050FY 2010 Marketable Borrowin

g g Ran

ge*** 1000-1600

* Primary Dealers reflect average estimate. Based on Primary Dealer feedback on July 30, 2009.** Ranges based on errors from 2004-2008.*** Based on Primary Dealer feedback on July 30, 2009.

Office of Debt Management
The current auction calendar has addressed recent changes 

needs

Security Recent Size, $ Billions4 week 13 week and 26 week bills 31 31 31

Announced through 8/3/09

4-week, 13-week, and 26-week bills 31, 31, 3152-week bills 272-year note 42 per month3-year note year note 35 per month 35 per month5-year note 39 per month7-year note 28 per month10-year note 60 (22, initial; 19, 1st reo

19 2nd reopening 19, 2nd reopening)

30-year bond 36 (14, initial; 11, 1st reo

11, 2nd reopening)

5-year TIPS year TIPS 14 (8 initial + 6 reopenin

14 (8 initial

+

6 reopenin

10-year TIPS 14 (8 initial + 6 reopenin20-year TIPS 14 (8 initial + 6 reopenin

Office of Debt Management
Based on the OMB budget released in May 2009, borrowing 

remain elevated

A l D fi it OMB 5/09

600700800

Interest Expense as 

Interest Expense as % of GDP RHS

Billions ($)

-2024

0

500

DP

Annual D

efi

cit

s OMB 5/09 Budget 

Estimates

Surplus/Deficits$ millions (LHS)

Billions ($)

100200300400500

10-y R

-10-8-6-4

-1,500

-1,000

-500

Percent of GD

Surplus/Deficits as a Percentage of GDP (RHS)

Net Marketable Borrowing a

0

100

1940

1943

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

Interest Expense LHS

-14-12

-2,000

,

1950

1953

1956

1959

1962

1965

1968

1971

1974

1977

1980

1983

1986

1989

1992

1995

1998

2001

2004

2007

2010

2013

2016

2019

Debt as % of GDP OMB 5/09 Budget Trillions ($)

20%25%30%35%

100%120%140%

2025

Held by Public Held by Govt

Gross Debt % of GDP

Estimates

5%

10%15%

Net Marketable Borrowing as % of GDP

40%60%80%

1015

Held by Public%

Office of Debt Management

-10%

-5%

0%

1941

1943

1945

1947

1949

1951

1953

1955

1957

1959

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

Net Marketable Borrowing

0%

20%

05

1940

1943

1946

1949

1952

1955

1958

1961

1964

1967

1970

1973

1976

1979

1982

1985

1988

1991

1994

1997

2000

2003

2006

2009

2012

2015

2018

Held by Govt Accts%
What adjustments to debt issuance if any should Treasur

What adjustments to debt issuance, if any, should Treasur

consideration of its financing needs in the short, medium, aterm? 

Office of Debt Management
TBAC Presentation to Treasu

August 4, 2009
TBAC Presentation to Treasu

TIPS

August 4, 2009
Outline

• History and Milestones• Investor Base• Value as Forecasting Tool

• Cost / Benefit

• Recommendations / Conclusions
TIPS Program Goals

• TIPS program started in 1997• Goals:

– To foster diverse investor base

– To generate inflation credibility

– To provide provide monetary monetary authorities authorities a real time market based measure measure of infl

infl

expectations.

Goals largely met despite well known liquidity issues.

Ma rke t Value o f All U.S. TIPS

$510,973

400,000500,000600,000

n

100,000200,000300,000

U.S. $millio

0

97 98 99 00 01 02 03 04 05 06 07 08 09
TIPS Milestones

TIPS Program Historical Milestones

05/16/96 Treasury Secretary Rubin announces the intention to issue Treasury inflation-indexed securities09/25/96 President Clinton and Treasury Secretary Rubin announced the terms and conditions of the first Treasu

President Clinton and Treasury Secretary Rubin announced the terms and conditions of the first Treasu

security

01/29/97 First 10y TIPS auction04/09/97 First 5y TIPS auction04/08/98 First 30y TIPS auction

06/30/98 Final rules on fungible inflation-indexed STRIPS were published09/01/98 Treasury begins selling series-I savings bonds09/29/98 Treasury announces regular quarterly schedule for TIPS and discontinues 5y TIPS10/31/01 Treasury eliminates 30y TIPS because of lower borrowing needs07/15/02 First 5y TIPS matures11/30/02 TIPS are stripped for the first time04/30/03 Treasury expands 10y TIPS auctions to 4 per year with two new issues per year02/08/04 CPI futures begin trading at CME05/05/04 Treasury announces the introduction of 20y TIPS and reintroduction of 5y TIPS07/27/04 First 20y TIPS auction10/26/04 First reintroduced 5y TIPS auction01/15/07 First 10y TIPS matures01/22/08 TIPS index market value hits $500bn
TIPS Trading Regimes

10y Real Yield

5.00

10y Implied Inflatio

4 00

1.502.002.503.003.504.004.505.00

1 001.502.002.503.003.504.00

-

0.501.00

Jan 97 Jan 99 Jan 01 Jan 03 Jan 05 Jan 07 Jan 09

-

0.50

1.00

Jan 97 Jan 99 Jan 01 Jan 03 J

• 4 periods• 1997 – 2000, new and novel asset class, not well understood.• 2001 – 2008 (H1) increasing increasing investor investor acceptance acceptance, hedge funds active.

• 2008 (H2) market breakdown due to forced de‐levering as well as disorder

funding trades

• 2009 – hedge funds out, new more diverse investor base (more later)
2008 Q4

• Increasing spread between cash and swap based measures of expected inflatio

forced de‐levering levering and disorderly disorderly unwinds unwinds of funding funding trades. (Inflation (Inflation swap im

im

measures historically trade higher than TIPS implied breakevens due to funding 

Spread between Inflation Swaps and TIPS Breakeven 

Inflation Rates Inflation Rates

120 0140.0160.0180.0

ps)

20.040.060.080.0

100.0

120.0

Spread (bp

0.0

7/21/2004

11/21/2004

3/21/2005

7/21/2005

11/21/2005

3/21/2006

7/21/2006

11/21/2006

3/21/2007

7/21/2007

11/21/2007

3/21/2008

7/21/2008

11/21/2008

3/21/2009

7/21/2009

Date
Only Explicit Inflation Hedge

• Currently retail investors have proportionately a far higher allocation to TIPs funds 

Nominal Treasury funds.

• Recently (2009) have seen large additional flows from Central Banks and Sovereign W

... these are b h ot strategic and tacti l ca .

• Domestic Pension Funds who don’t already have allocations are considering (private 

A t i TIPS F d N i l T 

To tal U.S. Trea sury Ous tanding Ma rke table Se curitie s

Assets in TIPS Funds vs. Nominal Treasury 

Treasury Bonds

14%

TIPS

12%

TIPS: 

Treasury Notes

74%

Nominal Treaury: Total

Fund Assets

63%
Investor Base 2008

(educated guess)

Total Dedicated

Cent

Bank

Sovere

Wealth 

10% CIPS 6%

Pension 

Tactical

40%

Fund

(direct holdings)

17%

Dedicated

60%

Tactical:- Hedge Fund- Bank Prop Desk- Asset Manager-Central Banks- Sovereign Wealth Funds

- Asset Manager is inclusPension Fund, Central BSovereign Wealth Funds

Sovereign Wealth Funds

- CIPS- Corporate inflatioprotected security (mostowned by high net worth
Investor Base 2009

(case study from one asset manag ) er

2009 sees increased allocation from Sovereign Wealth Fund, Central Bank

200

Pension 

Funds

15%

Existing Stock

2009 Flows (ne

-50

0

50

100150

15%

Funds

60%

Sovereign 

Wealth 

Funds/ 

Central 

160%

40%

-100

-50

Sovereign

Wealth

Funds/Central

Banks

Funds 

Banks

25%

• Fund Flows: Retail net positive.

Offset by Insurance Companies removing TIPS from VA offer(Difficult to hedge.)

• Pension Fund/ Endowment: Out flow to fund benefits/ operations

Pension Fund/ Endowment: Out flow to fund benefits/ operations. 

Cover losses in equities, hedge funds, private equity investme
Implied vs. Realized Inflation

• Only liquid, market based indication of inflation expectations.• TIPS do a reasonable j bo of f i orecasting future i fl i n at on

TIPS Implied Inflation and One Year Forward Realized 

Inflation R^2 = 0.79

3456

d Inflation 

-1

012

3

d / Realized

(%)

Implied Inflation : 5 yr TIPS1yr Fwd Realized Inflation

-3-2

Jan-02 Jul-02 Jan-03 Jul-03 Jan-04 Jul-04 Jan-05 Jul-05 Jan-06 Jul-06 Jan-07 Jul-07 Jan-08

Implied1yr Fwd Realized Inflation

Ja J Ja J Ja J Ja J Ja J Ja J Ja

Date
TIPS Real Yields vs. Real GDP

• TIPS Real Yields strongly correlated with Real GDP growth.

• Lead / Lag varies.

TIPS Real Yield and Real GDP Growth

5%3%4%4%5%

eal Yield

2%2%3%3%

DP Growth / Re

2 Yr MA YoY GDP5 Yr TIPS Real Yield

0%1%1%

Mar-96Mar-97Mar-98Mar-99Mar-00Mar-01Mar-02Mar-03Mar-04Mar-05Mar-06Mar-07Mar-08Mar-09

GD5 Yr TIPS Real Yield

Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar Mar

Date
Real Borrowing Costs Lower

Relative Relative to GDP In TIPS Era

Implied Real Yields and Real GDP

6%8%

10%12%

d/GDP

2 Yr MA YoY GDP5 Yr Implied Real Yield*Ave GDP - RY, 1979 - 1997Ave GDP - RY, Post 1997

-2%

0%2%4%

6%

mplied Real Yield

Above Real Bl R l

-6%-4%

Mar-79

Mar-81

Mar-83

Mar-85

Mar-87

Mar-89

Mar-91

Mar-93

Mar-95

Mar-97

Mar-99

Mar-01

Mar-03

Mar-05

Mar-07

M

ImAbove Real GDP growth Below Real GDP growth

Possibly higher borrowing cost on TIPS issuance more than offset 

Date

* 5 yr nominal – trailing one yr inflat

lower cost on the much larger nominal issuance. Inflation credibility important! 
Tax Receipts Move With Inflation

Change in Tax Receipts and Inflation

R^2 = 0 64 R^2 = 0.64

2025

CPI

05

1015

ange Taxes / C

-15-10

-5

468024680246802468

(%) Ch

a

CPI YoYTax Receipts

Jun-7

Jun-7

Jun-7

Jun-8

Jun-8

Jun-8

Jun-8

Jun-8

Jun-9

Jun-9

Jun-9

Jun-9

Jun-9

Jun-0

Jun-0

Jun-0

Jun-0

Jun-0

Date

Federal tax receipts a natural hedge for inflation pay out in TIPS
Why have TIPS ‘not taken off?’

• TIPS illiquid only when compared to nominal coupon treasur

trading as well as investment instruments.

• Potential Potential investors investors often question question Treasury’s Treasury’s commitment commitment to 

• TIPS market dominated by buy and hold investors

• However :

– Understanding Understanding of the mechanics mechanics of TIPS is growing growing.

– Understanding of the need for TIPS in a diversified portfolio co

need to hedge inflation risk is growing!

– New classes of investors (Sovereign Wealth Fund, Central Bank

strategies) strategies) entering entering markets markets, trading trading styles need to, and will ad

• Treasury needs to affirm commitment to keep this momentu
Recommendations

• More frequent, smaller auctions.

– Liquidity Liquidity often decreases decreases between between auctions auctions. The auctions auctions th

th

sometimes help discover prices far from where the market w

• Commit to issuing 5 yr TIPS.

– This sector is developing an investor base with Central Banks 

investors who want inflation protection without duration ris

profile compared to nominals also argues for shorter maturi

• Reintroduce 30 yr TIPS.

– Natural, after reintroduction of 30 yr Nominal Bonds.

• Modestly Modestly increase increase size of TIPS as percent percent of overall overall portfo

portfo

– Reaffirms inflation credibility. Market could probably handle 

base is growing.
TIPS and Nominal Maturity Profile

45 0%50.0% % of total TIPS

% of total Nominal Treasuries

35.0%40.0%45.0%

% of total Nominal Coupon Treasuries

TIPS Under represented

TIPS Over represented

20.0%25.0%30.0%

5.0%

10.0%15.0%

0.0%

TIPS <1Yrs TIPS 1-3Yrs TIPS 3-5Yrs TIPS 5-7Yrs TIPS 7-10Yrs TIPS 
Conclusions

• All reasons for the introduction of TIPS still valid

– Di if vers y i t nves or base– Inflation credibility– Market based measure of inflation expectations

• TIPS are recovering from the debacle of Q4 2008.

• TIPS are growing in acceptance by main stream investors, and also 

new set of investors.

• There could come a time when these investors investors prefer Real debt to N

N

• TIPS should continue as one of the cornerstones of Treasury issuanc

• Treasury should be unequivocal in its plan to continue TIPS issuance
TBAC Presentation to Treasu

Market Conditions

August 4, 2009
Economics
Economics

•Debt as a % of GDP is rising and nearing a post‐war high. The U.S. Debt‐to‐GDP ra

remain far lower than Japan and only slightly above the long‐term average.

•Tax receipts receipts lag during economic economic recovery recovery cycles creating creating a larger, lingering lingering fundin

fundin

the recovery has begun and yields have begun to rise.

•Consumption rates will remain lower and a drag on forward growth as the Baby B

generation begins to de‐leverage and retire over the next 5 to 20 years.

•There has been significant money flow out of risk‐free assets into risk assets since 

credit spreads have tightened substantially with it.

•Equities, commodities, the U.S. Dollar, credit spreads and Treasury yields have all 

become hig y hl correlated.

21
Federal Govt. Budget Balance as % of GDP

6%0%2%4%

-6%-4%-2%

-10%

-8%

-14%-12%

1946 1951 1956 1961 1966 1971 1976 1981 1986 1991 1996 2001 

Dotted L

22

Proj
It Will Likely Take A Number of Years To Fill the US Funding 

Federal Revenues and Expenditures as a % of GDP

28%24%26%20%22%16%18%14%

1953 1958 1963 1968 1973 1978 1983 1988 1993 1998 2003 

Expenditures Revenues Dotted L

23

Proj
Long Term Debt/GDP Levels – Still Near Long‐Term Avera

120 %

80 %

100 %

60 %20 %40 %

 %

1790 1800 1810 1820 1830 1840 1850 1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 

Govt Debt as % of GDP Long-Term Average (40 Years)

24
Global Sampling of Public Debt/GDP Ratios

180120140160

80

100

204060

0

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 

US UK Japan Italy Brazil Germany

25
Supply Pressures Linger After Recessions End As Treasury Rec

40%25%30%35%10%15%20%

5%0%5%

-10%

-

1971 1973 1975 1977 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 

Recession YoY % Changes in Publicly Held Treasury Debt

26
Cyclicality of Tax Receipts

201015

h

505

scal Year yoy % ch

-15-10

-5

Fis

-20

1970 1974 1978 1982 1986 1990 1994 1998 2002 2006 

Federal receipts Nominal GDP Dotted L

27

Proj
Household De‐Leveraging Has Only Just Begun

Debt/Income and PCE/GDP

140% 

Boomers turn 30

90%

100%110%120%130%

Boomers turn 30

50%60%70%80%90%

1959 1964 1969 1974 1979 1984 1989 1994 1999 2

Boomers 

• Borrowing has increased significantly over the last 25yrs• Beginning in the mid 1980’s PCE soared as a share of GDP while Debt levels spiked

1959 1964 1969 1974 1979 1984 1989 1994 1999 2

Debt/Income (L) PCE/GDP (R)

• Beginning in the mid-1980 s, PCE soared as a share of GDP while Debt levels spiked• Demographics and loosening lending standards fueled the excesses• The shaded area is when the peak boomers (1957) started the housing formation years. More recently, boom

college bills/savings and diminished consumption... 

28
Personal Savings Rate Heading Into Former 6% to 12% Ra

US Personal Savings as a % of Disposable Personal Income

16101214

468

Savings (%)

202

-4-2

1959 1964 1969 1974 1979 1984 1989 1994 1999 

US Personal Savings

29
S&P’s High Correlation with Various Assets

14001600 50

100

2s-10s

14001600

4.55.0

10 Year

14001600

O

800

10001200

1400 100

150200250 800

10001200

1400

2 53.03.54.0

800

10001200

1400

600

Oct-07 Apr-08 Oct-08 Apr-09

300

S&P (L) 2s-10s (R)

600

Oct-07 Apr-08 Oct-08 Apr-09

2.0

2.5

S&P (L) 10 Year Yields (R)

600

Oct-07 Apr-08 

S&P (L) Cr

Corporate Bond Index Euro

120014001600 100

200300400

p

120014001600

600800

1000

Oct-07 Apr-08 Oct-08 Apr-09

500600700 600

800

1000

Oct-07 Apr-08 Oct-08 

30

S&P (L) Corporate Bond Index (R) S&P (L) Euro/USD (R)
Long Term Inflation Expectations Still Contained

University of Michigan 5 year Inflation Expectations

10

89567342

1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2

University of Michigan Inflation Expectations

31
Bills Bear the Burden Initially, Now Rebalancing

140010001200

600800

Billions of Dollars

200400

0

FY2007 FY2008 FY2009

Net Coupon Borrowing Net Bill Borrowing

32
The Mortgage Market
The Mortgage Market

•Conventional mortgage origination has picked up as spreads have narrowed cons

the advent of the Fed QE Purchase program and all credit markets are in the proc

normalizing.

•However, traditional mortgage pass‐thru buyers have begun to step away from th

uncertainties surround the eventual unwind mechanism and timing of QE mortga

•Credit availability remains selective and concentrated in certain pockets.

•ARM origination, a major contributor to housing market affordability over the las

remains non‐existent.

•Current coupon 5/1 ARMs are just beginning to adjust but remain flatter vs. 30 yr 

fixed rate coupons than historical norms, despite a steep yield curve environmen

•Option ARM recasts are about to rise exponentially and force higher delinquency 

•More concerning, prime mortgage serious delinquencies are 4x higher than 2 yea

lagging the rise in the Unemployment Rate.

34
Fed Buybacks Help Floor Spreads

100 

60802040

-20

0

-40

Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 May-09 

MBS Purchases (R) Net Issuance (R) MBS Current Coupon OAS (L)

35
All Mortgage Originations by ARM/Fixed & ARM Share of Mortg

3000 200025001500

$Billions 

500

1000

0

2000 2001 2002 2003 2004 2005 2006 2007 2008 

Fixed (L) ARMs (L) ARM Pct (R)

36
Option ARMS, Projected Recasts

Recast Schedule Balance ($bln) by Orig Year: Assumes Rates Follow the Forward Curve, and borrowers currently making the minimum pmt will continue to do 

3525301520

ance ($bln)

1015

Bal

05

3Q2009 4Q2009 1Q2010 2Q2010 3Q2010 4Q2010 1Q2011 2Q2011 3Q2011 4Q2011 1Q2012 2Q2012 3

2004 2005 2006 2007 Quarter

37

Proj

2004 2005 2006 2007 Quarter
Prime Mortgage Delinquencies

4.53.54.02.53.0

elinquent Loans

1 01.52.0

% De

0.51.0

1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 

Prime Delinq 60+ & Fcl

38

Prime Delinq. 60+ & Fcl
Volatility
Volatility

•Realized and implied volatilities remain at heightened levels vs. historical norms.

•Zero‐Interest Rate Policy is keeping volatility on the front‐end lower but elevating 

the longer‐end as long term inflation inflation expectations expectations swing wildly.

•The negative convexity profile of the mortgage market has worsened with QE pur

•Mortgage servicers, originators, and bank portfolios are driving the demand for v

Street cannot source it, creating a chronic structural net short volatility position i

marketplace.

•There are no natural sellers of volatility left in the market with the collapse of hed

and leverage along with less retail appetite for structured note product.

40
Realized Volatility Mostly Near Historic Highs

3M x 2Y Realized Vol

1416

3M x 10Y Realized Vol

1214

68

1012

68

10

12

24

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

24

'99 '00 '01 '02 '03 '04 '05 '06 

1Y x 2Y Realized Vol 2Y x 10Y Realized Vol

8

101214

8

101214

2468

'99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09 '10

2468

'99 '00 '01 '02 '03 '04 '05 '06 

41

99 00 01 02 03 04 05 06 07 08 09 10 99 00 01 02 03 04 05 06 
The Curve is a Driver of Market Volatility

The 2y-10y CMT Curve and 1y10y Vol

12 1011

89

bps per day 

6745

Oct-98 Oct-99 Oct-00 Oct-01 Oct-02 Oct-03 Oct-04 Oct-05 Oct-06 Oct-07 O

1Yx10Y Normalized Vol (L) 2s 10s (R)

42

1Yx10Y Normalized Vol (L) 2s-10s (R)
Mortgage Volatility (bps)

161214

8

10

bps per day

462

Jan-06 Jul-06 Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 

1M 2M 3M

43
Treasury Auctions / Supply
Treasury Auctions / Supply

•Secondary trading volume is falling despite increased supply due to shrinking Dea

sheets and leverage.

•Too much attention attention paid to auction auction mechanics mechanics such as auction auction tails and too little 

to market movements in the weeks prior to supply periods.

•Bid‐to‐cover ratios are rising to record levels.

•Foreign auction participation rising and meeting supply needs.

•Global Central Central Banks remain significant significant and steady buyers in the auction auction process process.

•Liquidity has returned to on‐the‐run issues. However, off‐the‐run liquidity remain

QE purchases have been concentrated in on‐the‐runs and real money and Centra

sponsored the on‐the‐runs. Dealer balance sheets and rising VAR considerations 

factor.

•There is room for further TIPS issuance as investor appetite for inflation protectio

commensurate with QE policies.

•Issue sizes in the intermediate coupon sector are nearing market capacity but we 

retail demand for new maturities maturities such as 4yrs, 20yrs, or 50yrs. Instead, Instead, we see d

room for 2yr, 10yr, TIPS, and possibly Putable issuance.

•Treasury repo settlement fails have declined significantly since the introduction o

rate trading.

45
Treasury Supply Surges, Market Volume Lags as Balance Shee

200 150175100125

(in billions)

507525

Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 

30 Day Coupon Volume (L) Publicly Held Tsy Debt as % of GDP (R)

46
More Evidence of Recent Balance Sheet Constraint in UK Gilt 

Gilt Futures Volume

180120140160

cts

80

100

120

ousands of contrac

204060

(in tho

0

20

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 

Gilt Futures Volume 30 Day Moving Average 255 Day Moving Average

47
Treasury Auction Tails

2Y Tails

024

-6-4-2

5Y Tails

6

-2

024

-6-4

10Y Tails

468

-6-4-2

02

4

48

-8

2000 2001 2002 2003 2004 2005 2006 2007 200
5 Year Yield Changes in Week Before the Auction

40bp20bp30bp10bp

0bp

10bp

-30bp-20bp-10bp-40bp

Aug-03 Feb-04 Aug-04 Feb-05 Aug-05 Feb-06 Aug-06 Feb-07 Aug-07 Feb-08 Au

5 Year Yld Changes Before Auction

49
Higher Supply Has Not Generally Hurt Cover Ratios

3.54.0

354045

3.03.5

1.52.02.53.0

1015202530

1.52.02.5

1.0

5

'86 '88 '90 '92 '94 '96 '98 '00 '02 '04 '06 '08

05

2Y Size 2Y Cover Ratio Linear (2Y Cover Ratio)

1.0

'98 '99 '00 '01 '02 '03 '04 '05 '0

5Y Size 5Y Cover Ratio Li

3.5 25 3.5 

2.02.53.0

2.02.53.0

101520

1.01.52.0

'98 '99 '00 '01 '02 '03 '04 '05 '0

30Y Size 30Y Cover Ratio Lin

1.01.52.0

'98 '99 '00 '01 '02 '03 '04 '05 '06 '07 '08 '09

05

10

10Y Size 10Y Cover Ratio Linear (10Y Cover Ratio)

50

10Y Size 10Y Cover Ratio Linear (10Y Cover Ratio) 30Y Size 30Y Cover Ratio Lin
Foreign Investors Rise to the Supply Challenge

2025

lions of $) 45% 50% 2025

lions of $) 

5

1015

gn Investor Award (Bill

35%40%

5

1015

gn Investor Award (Bil 

0

'02 '03 '04 '05 '06 '07 '08 '09 '10

Foreig

30%

2Y Foreign Ownership of TSYs as % of Outstanding (R)

0

'02 '03 '04 '05 '06 '07 

Foreig

5Y Foreign Ownership of TSYs as % 

7

$)50% 1.6

$)

3456

or Award (Billions of $

40%45%

0.60.81.01.21.4

or Award (Billions of $

012

'02 '03 '04 '05 '06 '07 '08 '09 '10

Foreign Investo

30%35%

10Y Foreign Ownership of TSYs as % of Outstanding (R

0.00.20.40.6

'02 '03 '04 '05 '06 '07 

Foreign Investo

30Y Foreign Ownership of TSYs as 

51

10Y Foreign Ownership of TSYs as % of Outstanding (R 30Y Foreign Ownership of TSYs as 
Total Primary Dealers vs. Rolling Volume

350 250300150200

Billions of $

50

100

0

1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 

Primary Dealers Treasury 10 Day Coupon Volume (L)

52
Gross TIPS Issuance vs. Gross Treasury Issuance

500350400450

ns $

200250300

Issuance in Billion

100150200

Quarterly 

0

50

Mar-00 Mar-01 Mar-02 Mar-03 Mar-04 Mar-05 Mar-06 Mar-07 Mar-0

TIPS Issuance (L) Tsy Coupon Issuance (R)

53

TIPS Issuance (L) Tsy Coupon Issuance (R)
Net Treasury Issuance Less Fed Buybacks

200140160180

80

100120

4060

0

20

Apr-09 May-09 Jun-09 Jul-09

Net Treasury Issuance Buybacks Gross Issuance

54

Net Treasury Issuance - Buybacks Gross Issuance