New type of (USA) bond ...appeal to investors concerned that the Fed’s pledge ...and other stimulus will spark inflation.

Treasury Eyes First New Debt Type Since TIPS

 

By Liz Capo McCormick - Oct 24, 2011 7:26 AM ET

Bloomberg

The U.S., seeking to attract investors who might otherwise avoid Treasuries amid a $1.3 trillion budget deficit, is considering the sale of floating- rate notes in what would be its first new security since it began offering inflation-linked debt 14 years ago.

The Treasury Department said this month it asked Wall Street’s biggest bond dealers for recommendations on structuring securities with coupons that rise or fall with benchmark rates.

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While the government’s interest in offering a new type of bond may signal that it doesn’t expect deficits to diminish anytime soon, the securities would likely appeal to investors concerned that the Federal Reserve’s pledge to keep the federal funds rate at a record low through mid-2013 and other stimulus will spark inflation.

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Falling Yields

The Treasury has had little problem generating demand at its bond auctions even with the amount of marketable U.S. debt outstanding rising to $9.625 trillion from $4.339 trillion in mid-2007 and Standard & Poor’s cutting the U.S.’s credit rating on Aug. 5 to AA+ from AAA. Yields on 10-year notes fell to as low as 1.67 percent last month from 5.32 percent in mid-2007.

There is still a large group of investors who are spurning Treasuries, including Leon Cooperman, the chairman of hedge fund Omega Advisors Inc., who said last week during a presentation at the Value Investing Congress in New York that he “wouldn’t be caught dead owning a U.S. government bond.”

There are signs that foreign demand may be diminishing. Fed data show its holdings of Treasuries on behalf of central banks and institutional investors outside America plunged $76.5 billion in the seven weeks ended Oct. 12, the steepest drop since 2007, to $2.69 trillion.

“If rates go up it could cause problems for the government because they will have to pay a higher interest rate,” Campbell Harvey, a finance professor at Duke University’s Fuqua School of Business in Durham, North Carolina, said in an interview on Oct. 19. He’s also a researcher for the National Bureau of Economic Research, which determines when recessions begin and end.

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‘Convenient Product’

A floating-rate note whose coupon is reset at a rate that matches that of the six-month Treasury bill twice a year “would be a ‘convenient’ product” for which “demand will likely increase if rates are expected to rise,” TBAC wrote in its February presentation to the Treasury.

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The notes “would very likely be snapped up by investors, as many now buy fixed-rate Treasuries and use the swaps market to convert them into floating-rate debt anyway, to hedge the risk exposure to changing interest rates,” Moorad Choudhry, the head of business treasury, global banking and markets at Royal Bank of Scotland Plc in London, said in an Oct. 18 interview.

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