The Treasury Market: Don't Fix What's Not Broken
A recent report by the Democratic Study Group recommends a new debt management policy by the Treasury Department to create interest savings on the financing of the debt and to spur economic growth. In spite of its good intentions, several of the basic concepts in the report are flawed and could be extremely unsettling to the financial markets if adopted.</br></br>The heart of the report centers on the fact that there is an unusually large yield spread between the three-month Treasury bill and the 30-year Treasury bond, 424 basis points (2.95 percent vs. 7.19 percent as of Friday). Its conclusion is that if new Treasury financings that are being carried out in the longer-term issues were switched into the three-month T-bill sector, gargantuan interest savings would help pare the federal budget deficit. The interest paid on the debt was about $200 billion in fiscal 1992.</br></br>The second part of the thesis holds that if the Treasury were to stop issuing 30-year bonds (it sold $44 billion worth last year), the lack of supply in that sector would cause long-term interest rates to decline. This in turn would lead businesses to invest more, and home building would accelerate as mortgage rates fell. A study by Benjamin Friedman of Harvard University is cited as evidence that in reducing the 30-year financings, long-term interest rates would fall by "55 basis points."</br></br>One caveat: The Federal Reserve has to cooperate in keeping short- term interest rates low while the financing mix is being changed.</br></br>Although the numbers are compelling, the rationale is much too simplistic and clinical, leaving out reality and market expectations. The Treasury market has performed well in recent weeks because President Clinton and Treasury Secretary Lloyd Bentsen seem to be taking steps toward reducing the deficit. There also are indications that the Clinton administration's promised economic stimulus package may be moderate (around $20 billion) and that there is even a chance of further Fed easing of interest rates. All of these factors have contributed to the recent increase in bond prices. But this could change on a dime.