“When the ducks quack, feed them” — Wall Street proverb

In 2001, the U.S. Treasury decided to stop issuing 30-year bonds. The budget surplus made the long bond unnecessary and the new tax cuts were going to generate faster growth and abundant revenue.

It didn’t quite work out that way. Revenue fell, revealing a flaw in supply-side economic theory. The tax cuts didn’t pay for themselves, as their advocates had promised.

Then came the Iraq and Afghanistan wars, followed by the financial crisis. Pretty soon, it was apparent to anyone paying attention that the days of budget surpluses were long gone. Deficits had come to define the U.S. budgets.

Even with the U.S.’s huge funding needs, interest rates headed lower. The hunger for U.S. Treasuries remains unsated, so much so that today we seem to be facing a shortage of long bonds.

Here is a simple equation: Demand for Treasuries + ultra-low rates + big and persistent U.S. funding needs = the long bond.

If we were smart — and all indications are that as a nation, we’re not especially astute in our financial decisions — we would introduce a 50-year Treasury bond. Other nations have done so, most recently Canada.

Consider the reasons why:

1. Regardless of your views on debt and deficits, the U.S. has plenty of both. The long bond is a responsible way to address this, and to satisfy investor demand. You have to make hay when the sun is shining, and we have no idea how long this window will remain open.

2. Rates, although higher than their lows of last year, are still well below their long-term medians. Reissuance of long-term bonds allows the U.S. to take full advantage of this.

3. We may be at a generational selling opportunity for bonds. James O’Shaugnessy of O’Shaugnessy Asset Management has crunched the numbers, and he reaches the conclusion that low rates are unlikely to continue. The bull market in bonds, which began in the 1980s, is “3½ Standard Deviations above the long-term average for the bond,” based on rolling 40-year returns from 1900-2013 (see paper here).

4. The U.S. now funds long-term obligations with shorter-term financing. If we learned anything during the credit crisis, this is a recipe for disaster. Bringing the length of financing into closer alignment with our obligations simply is good financial stewardship.

5. The private sector is showing the way: Fixed-income investors have been lining up to purchase 30-year bonds from Bank of America, Apple, IBM, General Electric, Wal-Mart, Novartis, Pemex and others. Financial firms such as Morgan Stanley and JPMorgan Chase have been issuing perpetual notes with a fixed rate for 10 years, which then become Libor-plus bonds.

As we have seen, courtesy of the trouble in Ukraine, the U.S. remains the safe harbor when turmoil appears anywhere in the world. We have the world’s reserve currency, a simple fact that is unlikely to change any time soon. Perhaps most of all, there is a massive demand for Treasuries of all maturities. We would be foolish if we failed to respond to this market demand.

It’s time to feed the ducks.

 

Originally published here

Category: Markets

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

4 Responses to “Bring Back the Long Bond”

  1. Lyle says:

    So why not go whole hog and have the treasury issue us versions of the UK Consols that never mature? Then part of the objection on the right is squelched in that one never has to pay the principal back. One could issue inflation adjusted Consols also where the interest is adjusted by inflation. (but not the principal), i.,e. over time the apparent interest rate gets very high (at 2% inflation) the apparent interest rate would double in 36 years and go up by a factor of 8 over a century.

  2. supercorm says:

    Just when Canada issues 50 year bonds with a 2.96% interest rate…

    … taxed at 50% (marginal tax rate), that’s not even 1.5%, and barely cover inflation… for now.Either its a great trade because we’re going into a deflationary spiral -which is a bad thing-, or that inflation start to rise just a little -which will still be a bad thing.

    Low vol & low rates doesn’t mean low risk.

  3. RW says:

    The long bond should have never been retired in the first place — real interest rates have been very low and even negative for more than a decade — but there is no doubt plenty of buyers would bid and bid high if they do bring it back because there is still a serious shortage of safe assets globally; e.g., many of the largest buyers, including nation states, couldn’t care less if they receive a positive return on a given bond because what they want, what they must have, is trade/swap collateral and $USD reserves.

  4. ch says:

    Barry – your assertion here… “The hunger for U.S. Treasuries remains unsated, so much so that today we seem to be facing a shortage of long bonds.”

    …contradicts your post from only 3 months ago: http://www.ritholtz.com/blog/2014/02/biggest-buyer-of-treasuries-in-2013-da-fed/

    If the hunger for long-dated UST’s remains so steep, then why did the Fed buy 71% of them last year?