Monster U.S. Treasury Bond Supply, a Game Changing Event?

By: Michael_Pollaro

For the US Treasury bond market it’s time for some reflection.  What we have in front of us could be “game-changing.”  This, from a June 7 Bloomberg essay entitled, Treasury’s Summer Rally Not This Year Due to Supply:

Investors anticipating another “summer rally” may be disappointed as Treasury Secretary Timothy Geithner accelerates debt sales to finance a record budget deficit. After more than doubling note and bond offerings to $963 billion in the first half, another $1.1 trillion may be sold by year-end, according to Barclays Plc, one of the 16 primary dealers that are obligated to bid at Treasury auctions. The second-half sales would be more than the total amount of debt sold in all of 2008.

“I used to be a believer,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading at Deutsche Bank AG’s Private Wealth Management unit in New York, and has worked in the bond market since 1978. “The amount of Treasury debt that needs to be financed is a game-changer. Normally the seasonals work because of the ebb and flow in terms of the Treasury’s needs. That is no longer the case.”
We have been hearing a lot about this “game changing” Treasury supply all year, haven’t we?  Just how “game changing” is it?  Well, yours truly did some data mining, from US Government databases, and a bit of number crunching, and I think that Gary Pollock may be understating the case.  I refer you to the table at the end of this missive.  These numbers are ugly.  If this was a public corporation, I ask you, would you buy its long term debt at a mere 4.4%?

In the face of these numbers, what’s the market think?

Well, after pushing rates up a bit, demand was pretty good at the last 2, 5 year and 7-year Treasury auctions.  So, by implication, the market is not worried, at least at the short end, at least not yet.   But what about demand at the long end? 

The U.S. will conduct four auctions this week for the first time since the Treasury began issuing securities regularly in 1976. Today’s $8 billion auction of 10-year Treasury Inflation- Protected Securities will be followed by the sale $35 billion of 3-year notes tomorrow, $19 billion of 10-year notes the next day and $11 billion of 30-year bonds on July 9.

A real test for the Treasury bond market is at hand.

All I can say is with the pay-as-you-go Agency/Trust take of Federal debt waning, indeed about to become a drain, foreign demand, which the numbers show may be topping, better hold, or the Fed is going to have to step in and do some heavy buying.  And that, people, will be the last thing the Fed wants.  For if it does come down to the Fed as buyer of last resort, the specter of inflation, and the inflation premium in bond prices looms large.  In other words, the ultimate conundrum for team Bernanke could be right around the corner.  Stand aside and watch supply overwhelm demand, or monetize that supply and ignite inflation.  In either case, rates set go much higher.

Perhaps foreign money shows up and the Treasury bond market gets past this auction, relatively unscathed.  Perhaps another deflation scare puts a bid in the market.  Perhaps the market, at least initially, reacts favorably to an announcement of more Fed buying. You can’t rule any of this out.  But it’s all noise, because with the kind of deficits the Obama administration is producing, quite simply, Treasury bonds are grossly mispriced.

By Michael Pollaro

Email: jmpollaro@optonline.net

I am a retired Investment Banking professional, must recently Chief Operating Officer for the Bank's Equity Trading Division. I am also a passionate free market economist in the Austrian School tradition and private investor

Copyright © 2009 Michael Pollaro - All Rights Reserved
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