Why the US Treasury should issue zero coupon consols
OK. Imagine you have to manage the US Treasury’s bond issuance program to reduce debt service costs while maintaining the flow of safe assets at the maturity the market is clamouring for. One approach is the Bob Rubin approach from 2 decades ago and shorten maturities and issue TIPS. Here’s Rubin:
The Treasury Department has through its history focused on the most cost-effective ways to finance the federal debt. If you recall, in 1993 Treasury changed the maturity mix of government securities, something that was initially looked on with some skepticism, but which since has won considerable praise and is saving the taxpayers $7 billion. And today, we are announcing the intention to issue inflation protected bonds as a further step in this direction, as well as a step we believe can help promote savings in the country.
That’s the approach I would favour because issuing more short-dated paper at any one point in time when the yield curve is upward sloping saves you debt service costs.
But then again, Treasury yields are close enough now to record lows that you have to wonder if they can ever get much lower in our lifetimes. There’s an alternative view – championed by US Treasury Secretary Steve Mnuchin – that says lock in those rates now so that you don’t have to roll over that debt as often at much higher rates. Now I’m not talking about the permanent situation here just the debt issued today and the next couple of years as it relates to rollover risk for, say, the next 30-50 years, which is a pretty long time.
Imagine you could issue 30- or 50-year paper today at 3 or 4%. And you have a strong suspicion that – in the future – 2-year paper won’t yield 1.15% like it does today. You think it could be 4, 5 or 6%. Why not lock in the long-term rates of today and not have to roll over that debt for 30 or 50 years? Wouldn’t you save a shed load of money for the US government?
Those are the questions Mnuchin is asking. But I think he’s asking the wrong question. What he should be asking is this: what is the instrument that will best meet my need to lower interest rate costs for my government but also meet the markets’ need for liquidity. Isn’t that the question Bob Rubin asked when he created the TIPS market?
I think the answer to Mnuchin’s question is zero-rate consols. These would be perpetual bonds. So they have no rollover risk and they also pay no interest. They would be sold at a discount representing today’s interest rates and would meet the market’s need for long dated paper.
In the end, if you swap short for long as an issuer, you’re going to be paying a higher interest rate unless you issue zero-rate paper. If I were Mnuchin, I would only lengthen maturities, if I could swap interest-bearing paper for zeros.