Odd Lots - How the US Treasury Will Fund the Next $20 Trillion in Debt

Episode Date: August 12, 2024

When it comes to financing the US government's borrowing needs, the Treasury Department has some discretion in how it's done. It can sell 30-year Treasuries. It can sell 10-year Treasuries. It can sell a lot of three-month T-bills. Every quarter, it's always going to be some kind of mix. And in theory, the decisions about where on the curve it issues debt can have effects on the market and the economy, since different instruments have different liquidity and risk profiles. Recently, the Treasury has come under criticism for issuing a lot of short-dated debt. Some economists have dubbed it "Activist Treasury Issuance," with the allegation that Janet Yellen & Co. are purposely trying to counteract the impact of the Federal Reserve's quantitative tightening by issuing less debt at the long end of the curve. So is there anything to these criticisms? And how exactly does the Treasury go about making these decisions anyway? On this episode, we speak to a dissenting voice who argues that the Treasury has approached the task using the same methods it has always employed. Amar Reganti is a fixed-income strategist at Wellington Management and Hartford Funds, who earlier in his career spent four years at Treasury in the Office of Debt Management. He walks us through the Treasury's general issuance approach, why the funding mix changes over time, why it's been issuing more at the short end in recent quarters, and the overall strategy the government will use to fund what the Congressional Budget Office estimates will be another $20 trillion worth of borrowing over the next decade.  Read More at Bloomberg.com:Mnuchin Says It's Time to Kill the Treasury Bond He CreatedThe Trillion Dollar Legal Memo: FOIA Files Only Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at  bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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I'm Jill Wisenthall. And I'm Tracy Allaway. Tracy, every once in a while, and I mostly see this on Twitter, if I'm being honest, but every once in a while, I see people trying to make a big deal about, like, the quarterly refunding announcement by the Treasury is if it's going to be some, like, big market mover on par with like a Fed decision or something like that. I like how you say mostly on Twitter, like there's even a probability that you would be walking down the street and someone's talking about like debt issuance other than maybe looking at that

debt clock or whatever it is. Yes. Like it's not something that comes up in a bar specifically or I don't hear people talk about it on the street. I also do know if it's like a real thing that like people in markets actually care about or if it's just sort of this talking point, punded, sort of quasi-political thing. So we are recording this August 8th, but in late July, Nereil Rubini and Stephen Mirren put out this paper essentially saying that the nature of current issuance, which is that the government is borrowing a lot at the short end of the curve, I think they called it like this, like, stealth QE and maybe insinuated that there were sort of like political or specific economic motivations that causing them to issue where they do. So there's a lot

of like talk about this. Yes. So I am vaguely aware of some of this discussion. So the idea here for Robini and Mirren is they're calling it activist treasury issuance or ATI. And the idea, as you say, is maybe some of the stuff the treasury is doing and specifically choosing to kind of reduce the amount of longer term treasuries they've been issuing and rely more on shorter term bills. That's something they've done recently. The idea is that in so doing, they're essentially mounting this stealth QE, easing financial conditions in a politically sensitive election year, flattening the yield curve to stimulate growth. And then ultimately, per their calculations, there's a very detailed paper, it's worth like a hundred bips in a benchmark interest rate cut.

But it's being done by the Treasury, which is something that, you know, the Treasury is supposed to be independent. the Federal Reserve. And so there's this discussion about like political motivations and conspiracy and things like that. Right. And it's a very like interesting topic because the question is like, okay, there's some sort of framework that the Treasury uses to figure out where and when they're going to issue on the various curve and are they deviating from that in some way. And, you know, part of the timing here is that the Fed is currently doing QT, right? It's letting those longer dated assets roll off the balance sheet. And so then the question is like, oh, is the Treasury's purposely trying to counteract that by, okay, if the Fed is selling long-term debt,

is Treasury selling less long-term debt, muting the impact of monetary policy? All kinds of interesting questions. Anyway, we've never really done, I don't think, an episode on how governments manage debt and think about this challenge. And so it's a very timely time to do so and to sort of look at what really is going on. No, we haven't. And I'm really interested in this topic. I know you and I talk about the Treasury market, but we haven't gotten into those specific decision-making processes and the rules that maybe govern debt issuance.

All I know about the Treasury is the ultimate financial markets, Karen, because every quarter is out there asking for a refund. Good one, Tracy. Thank you. Thanks, Joe. No, I'm excited about this conversation. Let's do it. I'm really excited because, again, you know, there's the short-term question. There's the interaction of issuance in QT.

there's the election, there's the economic cycle, there's fighting inflation. And then we have huge deficits in this country and they're going to expect to be bigger and bigger. In February, the CBO put out an estimate that there's going to be another 20 trillion in accumulated deficits between 2025 and 2034. The estimate will certainly be wrong in one direction or another, but there is a lot of debt management out there. Anyway, I am excited to say we really do have the perfect guest. We're going to be speaking with Amar Raganti. He is a fixed income strategist at Wellington Management and Hartford Funds, but also, importantly, he spent four years 2011 to 2015 in the Office of Debt Management itself. He was a debt manager. He made these decisions, understands how they're made within the

Treasury. So Amara, thank you so much for coming on Odd Lots. Oh, thank you for having me. Totally. Someone I've really enjoyed talking to a meeting for a long time. Thrill to have you on the show, finally. Let's... start with like the really big question or sort of like maybe a framework's question. You know, when the Fed is thinking about, okay, we're going to issue 30-year treasuries or one-month-to-bills or whatever, you know, there are various factors that might go into that. There's demand for the market for duration. There's perhaps a desire to minimize total coupon payments over the life of the debt. There's other things that go into this question. There's an impulse for consistency and

reliability in the schedule of auctions itself. Talk to us how you would describe what the Treasury or the Office of Debt Management is solving for when it decides where on the curve to issue and how much. Sure. In sort of bold headlines, the Office of Debt Management would say its job is to finance the government's deficit at the lowest cost for taxpayers. The problem, of course, is that there's a lot of things behind that. The implications go beyond just sort of what you'd call a number that you could scratch down on a piece of paper. And then additionally, what you're trying to solve for

is something that you won't know ex ante, meaning like you won't know as you're doing it. You may know, may know after the fact because you wouldn't have known how you would have changed financial conditions if you had done something different. It's sort of loosely like Heisenberg, right? The moment you observe it or act on it, you're changing the very nature of the Treasury curve, and importantly, the Treasury ecosystem.

So Treasury and the Office of Debt Management are aware of this, this dynamic, that the fact is that when they act, they actually change the market pricing and microstructure that exists around what's supposed to be the world's deepest and most liquid sovereign debt market. So they try to actually take what I would call the most boring realm. they could possibly take. And that is something that's called regular and predictable. Now, we tossed this term around a lot. If you've even been ancillary to debt management practices, you know, using the words regular and predictable is almost like mentioned with like religious reverence, right? The idea is you're there not to surprise the market, not to shock it. Importantly, not to be a

source of volatility. And this was pioneered by Paul Volker, actually, in the 1970s to start a regular and predictable practice. But regular and predictable is there to accomplish a number of things. It's there to make sure that you are, one, not disturbing markets more than they need to be. Two, by laying out what you're planning to do and do it in a very slow and methodical way, you know, you are effectively feeding the larger treasury ecosystem. So it's not like, oh, the curve is shaped this way or it's steep this way. And we should, issue more. Your job is to actually look across the entire Treasury ecosystem, like, who are the participants who are involved, and then come up with a way of making sure that ecosystem remains

healthy. It's weirdly more like gardening or, like, maintaining a natural environment than what you think of, like, the tactical issuance of a normal corporate issuer. Gardening is a really nice analogy for it, actually, because I don't think, I mean, I only started, like, seriously gardening in the past couple of years. And the thing about gardening is people, we'll say it's like art, but it's art in multi-dimensions, right? Because you're thinking about times, so like what stuff looks like throughout the growing season. You're thinking about colors. And then everything is on a super long-term timeline. So you plant something now and you don't really see the impact until a year or so. Okay, wow, I just went. We could just talk about gardening.

No, okay, I want to move to a different analogy. So when I think about debt issuance, I used to cover corporate credit. And so I think about, you know, being a treasurer at a large multinational, like an Apple or a Microsoft or whatever, and the decision-making process there where, you know, if I decide there are favorable market conditions, I might go out and work with my bankers and decide to issue some debt. What is the difference between being a treasurer at a big company versus being U.S. Treasury? Oh, a vast difference, right? And I too started on the other side, as a corporate portfolio manager in the bond market, you'd look at companies coming to the market. They either needed cash or as opportunistic.

For the U.S. government and for the debt management office, it's very different. It's that you are always going to be at various points on the curve, whether or not at that point it's what I would call tactically a good thing. And, you know, this goes into that regular and predictable issuance cycle. And the point there, and this is how we get to cost, which is, again, different from how corporates measure cost, is that by being consistent, by helping this ecosystem thrive, you're going to create a liquidity premium, right? That because there is this regular and predictable nature to your issuance cycle, that people understand they're not going to be surprised that the availability of securities is going to be well calibrated to what the environment. needs. And when I meant environment or ecosystem, I meant the entire ecosystem. You want to service as broad and diversified group of investors as possible. And that includes people who will actively

short your securities, right? Because that provides a supply outside of auction cycles for people to buy and also help stimulate repo markets and so on. So you want to be sure that you aren't attempting to use pure price on what's on the yield curve as a point on what. why or how you should issue. Now, I want to be a little careful. There is a quantitative framework that Treasury has, and it's a model that, you know, a number of people collaborated on. Credit goes to people like Brian Sachs, Serena Ramoswamy, Terry Belton, Christossi, a number of others who built this model. And it sort of gives a sense of, okay, historically, based on a number of inputs, whereas Treasury benefited the most by issuing. That's like

important guidepost, but the more important part is the qualitative feedback that Treasury hears from its dealers, from investors, from central bank reserve managers who hold vast amounts of treasuries, and that all also feeds in along with the borrowing advisory committee into making issuance decisions. Right. And that feedback and the needs of various investors changes over time. And I mean, of course, in extreme periods, you know, March 20, 20, me everyone just wants the most liquid thing in the world, which is the shortest end of the curve. Obviously, other times there is a tremendous demand for duration and people want to buy it the long end. That all changes.

Let's just talk. Before we even get to the specific now, you know, you were in this office for years 2011 through 2015. What is the quarterly process? I know there's like a survey that goes out. They look at the curve, et cetera. There's the estimates for how much is going to need to be financed in that quarter. Can you walk us through the quarterly process that leads up to the announcement of this is the new auction schedule? Yeah, there's a number of pieces to it.

One is within Treasury, there's a separate office called the Office of Fiscal Projections, and their job is to sort of project out what the upcoming cash needs over a given quarter are likely to be. And once, you know, the debt managers have that information, they can start thinking about, you know, the various allocations among their regular securities. But obviously there's issues that they want to receive feedback on. So there'll be a primary dealer survey, which could address things like the composition of issuance, changes to issuance, or even other things like new products, issuance points, regulatory events that are impacting the demand for treasuries. So that goes out several weeks before the quarterly refunding process. Treasury then comes to New York and meets with a subset of these primary dealers at the FRBNY.

and then Garner's feedback and has sort of very candid back and forts with questions and here's feedback on what the issuance process has been thus far, really to kind of sample what's on the primary dealer's minds at that given point. Following that, you know, when they're back in D.C., they begin the process of preparing their presentation to the borrowing advisory committee, and already, you know, several months before, they've assigned what's called charges to individual members of the borrowing advisory committee. And these charges are specific questions the Treasury would like answered with the expertise and help of the borrowing advisory committee.

This could be things like blue sky ideas of what else should we be issuing. Or is there some impact likely to come on markets because of a change in regulations? It could span the gamut, right? Treasury doesn't ask these questions casually. It doesn't mean they're going to act on recommendations, but it gives a sense of what's on the Office of debt management's mind. Treasury will then meet with the T-back. They'll hear a presentation of the various charges present to the T-back, and then later on that day, the T-back will present to the secretary or the senior most Treasury official available. And then on that following day, there'll be a

release of the broadest amount of information. There's a release that morning as well, but over those two days, there's the release of the presentations, the minutes, the data packs. And that is the sort of signal to market on what issuance is likely to be. And there's a press conference that goes with this. And what's funny, as you guys have mentioned, is if you watch a Federal Reserve press conference and watch how tightly packed that room is, then you go to a Treasury quarterly funding press conference. Oh, poor Treasury. And you see how thinly staffed it is. Maybe I could actually get into one of those, because I'm probably going to get into a Fed Press conference, but we can probably get into that. But, and this is not deliberate, but it's there to be boring.

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But this whole discussion has kicked off because despite the fact that the U.S. government has a massive deficit, the U.S. Treasury has said that it is sort of tempering the increase in its issuance of longer-dated securities. So it's sort of backing away from it. I think in the most recent quarterly refunding announcement, they said they were going to keep the issuance of longer term debt, basically unchanged. Also, Tracy, just to add on to that, we have an inverted yield curve. So theoretically, if you wanted to borrow at the low, you know, one could say, oh, look, it's cheaper to borrow at the long end. Why are you selling all these bills when actually the cheapness is at the end? So this is the very essence of the current controversy. Yeah.

What is happening? And I know you're not a treasury now. But what is happening when the Treasury comes out with that kind of decision? Okay. So the first kind of framework you want to think about is, and you would ask this initially, is how do they make these directional issuance decisions? Well, the first kind of thing is that Treasury does look at long-term averages of where it is in its weighted average maturity, right?

Like when you add all these securities together, what's sort of the average maturity? And historically, it's been around 60, 61 months. Treasury is well above that right now. It's around 71 months. So it's actually pretty high up. The second thing... Which, just to be clear, most people would say, that's a good thing, right?

You want to term out your debt. Maybe if you're a corporate treasurer, you might want to do that. But there's a lot of arguments that you actually don't want to term out your debt. Oh, interesting. Okay. So...

Same more. Yeah. The first is, is that, yes, the curve is inverted. That's, if you decided to move issuance that way, chances are you could uninvert the curve. I'm not saying that's a definitive. depends on how much or how likely, you know, what else is happening in markets. The second thing is, is that as in a previous episode, I thought Josh Younger explained it really well. You know,

you could roll these three-month bills, you know, all the way out to 10 years, or you could issue a 10-year. And if you're sort of risk-neutral, there's no savings, right? Or there's no gain or savings. It just means that forwards get realized and effectively, it's effectively the same thing. So when Treasury does that, you're saying that over time, you're effective, making a tactical rates call that somehow that you think that 10-year rates or 30-year rates won't go substantially lower. That's the first thing. The second thing is that the sheer amount that you can put on the 10 and 30 year is going to be less than what you can put in the bills market. Now, that's just absent anything that the Federal Reserve is doing, that's just generally true, right?

Like it's just a broader and bigger, it tends to be a broader and bigger market. The shorter in. There's more demand for shorter dated securities. But the third thing is, is that what Treasury really is trying to do is look around across the ecosystem and say, hey, where should we be feeding securities to over time if we are kind of taking a risk-neutral sort of approach to this, right? That we're not extrapolating what forward curves are going to be. We don't know any more than a typical rate strategist or someone. We know what we don't know about how market rates evolve over time.

So because of that, our job is to help issue security. to where the biggest pools of capital are, because that's how you issue risk-free securities and keep up the health and demand for and liquidity of your asset class. So the biggest pool of money now, in particular, is still at the front end, right? The amount of reserves that have been created is really dramatic. Now, the pushback to this is, well, hey, the Federal Reserve created all these reserves,

and now you're sort of taking advantage of this, and you're issuing there. Now, as I might have mentioned before the show, every decade this criticism sort of gets leveled at Treasury, that to some degree you are standing in the way of monetary policy. Back in 2011 and 12, it was a very different set of people who had a critique. It was Larry Summers, Josh Rudolph, Sam Hansen, David Greenlaw, who had said Treasury was extending its long-term issuance and extending the maturity, the weighted average maturity of its debt while QE was going on. And it said, you know, the Fed is buying long-term securities and you're issuing long-term securities. You're getting in the way of the Fed. And just the flip side of the critique is now, which is that the Fed wants to tighten financial conditions. And by issuing shorter day-to-debt,

you're not allowing financial conditions to tighten as much as they should. The criticism back then was that they were potentially steepening the curve, whereas now people are like, oh, they're flattening the curve to stimulate growth. Yeah, to some degree that that's right. And Treasury's answer is usually remarkably consistent. We're announcing what we're doing well in advance of what we're going to do. If the Federal Reserve thinks this is inappropriate for monetary policy, it can absolutely take steps to do more. So the pushback in 11 and 12, or 12 and 13, I think, was the Fed can buy more, right? Like the Treasury is going to issue what it needs to issue for its financing needs in any given year or quarter.

But the Fed's trying to take duration out of the market back then and the Treasury is issuing duration. The Fed has the flexibility and freedom to do more. The flip side here is if the Fed thought term premium wasn't enough or the curve wasn't steep enough, the Fed has tools where it can steepen the curve. It could outright sell securities from the SOMA portfolio and steepen the curve. What Treasury is really trying to do is it's almost like you walk into a room, right, and you move a large piece of furniture, you move around the piece of furniture.

Like that furniture is not going to be moving dynamically, right? It's sort of set in its place. And the Fed as a central bank with multiple tools at hand can move around it, not saying rather easily, it complicates the job, but the whole point of regular and predictable is not just to signal to market participants, but also to signal back to the central bank

that this is what's happening. Joe, this is my second favorite topic, which is interior decorating. Oh, we're... Just talk about gardening and interior decorating. We can talk about this on the HGTV channel in the Discord. Maybe we'll talk about it there. So this is actually really interesting because if the auction schedule is laid out in advance,

if it's regular, et cetera, you can actually sort of test the proposition of whether the treasury is being activist by how quickly it changes. It sounds like... And the Fed has total freedom and total institutional acceptance of the idea. of agility, and that's we expect it of them. But if the Treasury were being activist in some way, that would be weird because we would see it very explicitly in a changing nature of auction. Sure. And in fact, in the paper you referenced that came out, the place that was pointed to was in Q3, Q4 of last year, when in the August refunding, Treasury had said, we plan to increase coupon

sizes. And there was a lot of noise around this. And you could see real yields really sort of steepen out. And then in the November refunding, Treasury was like, yeah, we're increasing coupon sizes, but it's not going to be that much. And real yields slammed back down. And in fact, we're well below those levels now. So it kind of behooves the point on whether or not, you know, that actually made a difference or not. So let's get more to the right now. I actually don't remember the numbers. Like, so the one that you said that average maturity currently for all outstanding debt is actually on the long side.

So to just. So just to get back to the 60 months, and the average has been historically about 60 months. 61, yeah. Okay, so just to get back to average would argue for actually doing what the Treasury is doing, which is issuing more at the short end of the curve. But why don't you talk to us about like what is the sort of split right now? And then more importantly, what are the overall market context, whether it's demand for duration, whether it's something about market microstructure, whether it's whatever.

going on that sort of tell the Treasury go shorter? Yeah. So one, it's trying to think about what your long-term averages have been and just sort of recalibrating a little bit over time. It's not a, and this is important. It's not a hard rule. You don't need to do it. You also can look at things like the ratio of bills to coupons outstanding.

Again, not a hard rule. So one of the sort of controversial things was that Treasury had typically given guidance saying we like to keep bill issuance around 20, outstanding about 20, 20% or issuance around 20% of the total issuance size. Where are we in now? We're like a few percentage points above, right? And this is caused among some academics, some consternation. But again, if you go to the 80s, it was 35%, right?

Like, it's fluctuated over time as issuance needs have taken place. And as well as, where are the largest sort of pools of money? Now, if you're going to issue into this environment with where you're trying not to cause lots of volatility, it would mean shortening right now. If there was an extraordinary demand for duration that was going on, there's no reason you need to shorten your wham. You could keep it where it's at. You could keep it constant. You could increase it a little bit. The UK, for example, has gone substantially higher in terms of the weighted average maturity. I think at times it's been at like 90 months. So the point is, is you're not constrained by any of these, what I'd call,

like rules, it's to really read the market microstructure. PostD. Frank, for example, Treasury understood that there would be a really substantial need for a lot of short-term, stable value collateral. People had to post-margin for derivatives, right? They had to keep effectively more cash-like things on hand. And Treasury reacted to that. It created the floating rate note as an example of something like that. The reason why the 50-year- and 100-year bond don't exist right now is that Treasury sees the market microstructure and doesn't think there's going to be regular and predictable demand at those levels. So every time that debate has come up, every time a new secretary comes in and thinks that they want to do something like that, they usually have not have to,

they walk it back because staff shows them like the analysis. Okay. So you mentioned T-back before the Treasury Borrowing Advisory Committee, which is like a representative group of market participants that advise the Treasury on things that the Treasury asked them to look at. And one of the things that Treasury has asked them to look at recently is the strategy for T-bills. And some people are interpreting this as like a sort of direct response to the ATI criticism where like, well, let's ask the market participants if they think this is some big conspiracy or if it matters or what the shape of T-bills should be. What does it mean that T-BAC is like looking at this? Yeah, they will often use the charges as a way of responding to criticism. And to be fair, they actually want a sort of

what I would call a deep dive into that. They want to know, are they inadvertently doing something that is causing consternation among market participants that's upsetting the sort of carefully laid out treasury ecosystem? And that's exactly the type of feedback that they want. I think where they, you know, you could take a little umbrage at was this idea of activist issuance as some type of political push because this is usually one of the most technocratic places within Treasury. The secretary generally has a lot of other things on his or her mind, everything from counterterrorism to the international affair side, which is financial diplomacy. And debt management is an important piece, but it is a piece of that. And you typically rely on your assistant secretary for financial markets

to really be that point person to handle that part of issuance. Yeah, I noticed that when you described the quarterly process for auction schedules, there was no point in which the Treasury Secretary walks in and say, hey, guys, it's an election year. We need to do this. Bloomberg Tech returns to San Francisco, June 3rd and 4th. Join me, Emily Chang, along with Tom Giles, as we convene the CEOs, investors, and innovators shaping what's next in technology. Powered by Bloomberg's Global Newsroom and unrivaled terminal data will break down the capital, connectivity, and big ideas driving the industry forward. Be part of the conversation. Register now at bloomberglive.com slash tech.

That's bloomberg live.com slash tech. Just yesterday, August 7th, great Bloomberg story, Steve Mnuchin says it's time to kill the new treasury bond he created. So he revived auctions of a 20-year bond, and apparently there's not much demand for it. Yield is higher than 10-year, yield is higher than 30-year. First of all, what is it about market structure and treasury that would cause something like a 20-year treasury to become orphaned?

that. Yeah. Well, first, you know, just on a little bit of pushback, yes, it's traded above the 30 year, but in, you know, in recent months, that spread has actually collapsed pretty, but it's still above the 30 year, and that's a fair point. There can be any number of things. The demand for a particular treasury or particular treasury security or a point on the curve is influenced by a whole lot of other things. So, for example, you know, why is the 30 year in such demand? Well, one, market participants already, you know, incorporated into their portfolios. Private sector issuers use it as a benchmarking security for their own issuance. So in a new issuance period for corporates, what you often do if you're an IGPM is you'll

take delivery of the new private sector bond by, you know, so-and-so company, and then you'll sell your 30-year treasury or you'll short that point in the curve. And that's how you're capturing the spread. That's a very normal occurrence. And that dynamic, you know, needs to build up. at different points on the curve. And some points, it's just not as useful. So it's very possible that the end demand,

whether it's usage of benchmark security, whether liability-driven investors like pension funds that seek to immunize interest rate risk, don't find it that useful, whether stripping activity around it is very limited. All of these things play into the overall demand for the security. Now, Treasury does its best ahead of time

to try to figure out whether that's really, that's going to be the case or not, it's had challenges of the 20-year. And as it happened in the early 1980s, when the 20-year program was canceled in 1986, it too showed a humped curve where the 20-year traded cheap to the 30-year point. So, yeah, it's certainly not been a resounding success. It's also only been four years. And that's not a particularly long time from the perspective of a debt manager. Yeah, just to that point, Tracy, it sounds like a lot of this is just sort of path dependency. Like if everyone's been doing 30 years and that's where you're used to benchmarking, then it could have been 20 years to begin with. But if it wasn't, then it wasn't. I was just going to say, that's where the gardening analogy is interesting, right? You've tilled and planted and kept like this one area really sort of well-nourished. And then you're trying to do it in an area that hasn't been there. It takes more time. And chances are it's probably not as fruitful immediately.

Thank you so much for coming back to gardening. I appreciate it. Yeah, I'll get grief for this, I think. So Joe mentioned the news story yesterday. And the other thing that happened yesterday, again, we are recording this on August 8th. It has been an absolutely torrid week, very dramatic week in markets. But we had a treasury auction that was pretty weak, I think, was the consensus. What constitutes a bad day for someone working in treasury? Like, what can go wrong?

Good question. Oh, wow. A lot of things can sometimes go wrong. So, you know, it was a three basis point tail on the 10-year auction. That's actually not, like, that's not great. It's not a disaster, but I think most people, they're already nervous and they see it. But given the rally you had in rate markets, you know, it's effectively saying at these levels, there might be a little bit of reduced demand and the levels need to back up a bit.

So this isn't something that would cause anyone to particularly blink. If you remember around the taper tantrum, that was a period of serious consternation because you were starting to see real weakness and tails in a series of auctions, and the Fed's communications around that time were, whether deliberate or not deliberate, we're injecting substantial amount of volatility. So for individuals approaching auctions, price discovery of what things should settle at was becoming very, very, very challenged. So that particular time was one where we were watching how these auctions were tailing.

The more tails you have, the less efficient, by definition, your auction. auctions are, right? Like, you're going to get them periodically, but if they're consistently tailing, or the flip side, if they're consistently coming through, substantially through the when issue market, you're again saying that price discovery is being challenged and it's not being transparent. So those are periods Treasury starts trying to figure out what's going on among the investor community. Is it external events? It's exogenous. You know, obviously the summer of 11 during the first downgrade, which is the first summer I started. in that office was...

That's like Joe and I starting financial journalism in 2008, like August 2008. That was a bad day, right? Like that was a bad summer for all intents and purposes. And oddly enough, it actually didn't impact Treasury demand one way or the other. Rates ended up actually rallying. But to Treasury officials, it was the reputation and the pristiness of the Treasury market that had been scratched, besmirched, right? And they felt somewhat unfairly at that point.

That was obviously a bad day. Anytime around debt ceilings are bad days. Anytime you question the full faith and credit, those are bad days. Almost everything else, it means that, hey, you need to do a lot more work on thinking about, are you really optimizing issuance for the lay of the land? What causes structural demand for duration to change over time? I mean, I guess there's just sort of the economic cycle. And, you know, again, we understand.

what happened in March 2020, give me the most liquid thing in the world. But when you sort of, like, think a little bit longer, are there ways that people in markets or economists or whoever else try to project demand for duration? And why is there a particular, and why now is there like people want the short end? Yeah, I think many have tried to come up with what I'd call a long-term demand framework for duration. I don't think anything has been particularly sound. you could argue demographics, but that's unclear. It probably has a lot more to do with policy rates and expectations around policy rates and growth and inflation that tells you how willing people are to go out on the curve and as well as like volatility, right? Because the further you go out on the curve, there's more money at risk on a per basis point movement.

So you could say in a narrow space, it's expectations of growth and inflation as well as expectations of volatility. of volatility. Like that would likely be the key driver for demand for duration. But there's a nuance to this. Are we talking funded or unfunded duration, right? So if I look at like the treasury curve and then I look at like the swaps market, well, the swaps markets trade through the treasury. You have negative swap spreads. So you could say synthetically the swaps market is the market for unfunded duration, right, where you don't have to put as many dollars to work. to get similar duration characteristics. And if you converted longer-term treasuries into swaps,

these would be SOFER plus instruments. And that's weird. Like, this dynamics existed for a long time, but it's a strange dynamic, because why would your risk-free government security trade at SOFER plus, not SOFER minus, when you get out to the longer part of the curve? And the answer is,

is that there's balance sheet charges to putting that much money to work is one. So that impacts, you know, sort of the demand and differential between funded and unfunded duration. The second is, are there other things you'd rather do with your cash versus go-buy treasuries, but yet you still need the duration? And this is the advent of the whole the differential between futures and cash treasuries and the treasury basis trade. And it's typically that there's investment managers who want to own credit, long-duration credit, but want to manage their duration synthetically. via futures. And that also causes that. And Stephen Kelly at Yale has written, you know, pretty authoritatively on this. And that could also be a signal for Treasury. And it's a counterfactual

to like a lot of the criticism out there of how could you say you should be issuing a lot more longer dated bonds when possibly the true price of duration is already telling you that the bonds you're issuing are not coming at the cheapest cost. Yeah. This is something that I think gets lost in the conversation sometimes, which is like, treasuries are not the only source of duration. And I'm about to throw in my third favorite topic, which is cooking. But like, if you are a fund manager, you're trying to like bake, this is a labor analogy. You're trying to bake like a yield and duration cake, right? And like often the general recipe or the guidance that you're following is like you're trying to match and hopefully outperform some sort of benchmark.

And there's like a degree of duration embedded in the benchmark. And I remember at various points in time, specifically, I think it was 2015. Like there was an argument that like the Fed was sucking up too much duration from the market because it was buying not treasuries but mortgage bond securities. And so no one could match like the hypothetical benchmark index. And so anyway, it's just a point. Just excuse for me to talk about baking. I mean, it could have just been a common complaint.

Normally, the benchmark providers try to take out the securities owned by the Fed, but there could have been operational issues in actually sourcing the cash duration that you need. So, like, this is a real issue. And I try to think of this as there is no one lens that you look at lowest cost, right? There's multiple lenses. And what Treasury actually steps back and says is if we keep doing, like the job we're doing of trying to maintain a liquid ecosystem, will earn a liquidity premium over time, over years, over decades,

versus, hey, we have a short wham or we have a long wham. And every time that experiment's really been done, where they pick a wham purely for cost, it's not ended that well. Omar Raganzi, thank you so much for coming on odd lots. That was really fantastic and cleared up a lot to me. That was really fun. This is like an all-time favorite episode of mine,

given that we talked about gardening, interior design, cooking, and debt management. That's great. Well, thank you for having it. Tracy, I really like that conversation. I'll just start with one sort of big picture thought, which is, I really think this is an important point that he made, which is that even if you're just trying to solve for the absolute minimum interest payments over time, that that doesn't necessarily say you should always

sell at the cheapest part of the curve. because of the importance of that healthy ecosystem, which is a long-term thing. Yeah, I've got three takeaways from that conversation, which was very fun. But number one ties into what you just said. So this idea that a government is different to corporates. And if you are a company, you're probably trying to term out your debt at the lowest possible cost. And to some extent, the government will be trying to reduce interest expenses. But on the other hand, it has to take into consideration the entirety of the current.

and the fact that it is actually providing a benchmark for other borrowers. Yes. And then the second takeaway is that reflexivity point. So the idea that as soon as you start issuing something, you can have an impact on the curve itself. And so the goal for the Treasury is really to be as risk neutral as possible, as Amar was saying. And then I guess the third thing that was really interesting to me was the relationship

between the Treasury and monetary policy or the central bank. and this idea that like, okay, maybe treasury issuance could have an impact on financial conditions, but it's not like the Fed is helpless here. And the Fed has other tools that it could use to offset changes in the curve. Totally. I thought that was a really excellent and useful point. It's like, yes, okay, there are, in this sense that there are times when the Treasury is issuing in such a manner that could be cross purposes with the Fed. But the question of whether it's like activist or has some sort of motives. One way to test that is like, is it still being done in a sort of predictable manner that was laid out in advance, right?

And so we want a Fed that reacts very quickly to market data and changing conditions and all that. And so we give the Fed a broad leeway to sort of change its mind, whatever it wants. And that's part of the institutional arrangement. If we started seeing that from the Treasury where it suddenly, you know, dramatically changing the auction schedule from one quarter or another or inter-quarter emergency, you know, and I don't even know. I guess that could be a thing. That sort of would be the test of like whether it's like activist or not.

Joe, can I say one thing? Please. I'm waiting to the very end of this conversation to say this because hopefully no one will hear it. But if you think about like how much. What analogy are you going to say now? Well, no, okay. I'm done with analogies. But if you think about the skepticism that has recently emerged, you know, courtesy of this Rubini and Mirren paper around something as sort of like boring and prosaic as treasury issuance, imagine what would happen if there was that trillion dollar coin.

Yeah, well, by the way, listeners should check out our great Bloomberg reporter. He's like a FOIA guru. He gets all these great documents. Jason Leopold actually got some. documents about the DOJ's commentary on the trillion dollar coin. So August 2nd, go check that out from Jason. You know, you made the point earlier about everyone, you know, benchmarking. And this is really important too, because with that Mnuchin piece, so it's like, well, maybe the 20 year is not necessary. It's like 30-year treasury. It's like, it's all kind of arbitrary, right? Like,

it could have been a 29 year. It could be 31, but we like round numbers for whatever reason. corporations benchmark off of them, et cetera. Like, it could have been that the longest part of the curve was the 20 year, and then there would be this longstanding practice of then corporations would likely be benchmarking their long-end issuance from the 20 year. But it really does speak to the sort of, again, the ecosystem point, the path dependency point, the stability point, the consistency point, that what you've been doing for a while on some level should be the benchmark for what you're going to do next.

You know, an interesting thought experiment is to think what financial markets would look like if humans weren't like predisposition to like round numbers. Oh, yeah. Like what if everything, instead of the 10 year, like what if the benchmark was, I don't know, a 9 or 11 year? I wonder how much difference. Right. Like, if we were a species that had 9 fingers or 12, then we would not be likely using base 10 as our monitor as our numerical system. And, you know, this could be an interesting sci-fi. a sci-fi story about a species that has a very developed financial system,

but they have 15 fingers and how it emerged in the use base 15th. Joe, we're on to my fifth favorite subject, science fiction, which comes after debt management. No, I think we should leave it there. Let's leave it there. Okay. This has been another episode of the All Thoughts podcast. I'm Tracy Alloway.

You can follow me at Tracy Alloway. And I'm Jill Wisenthal. You can follow me at the stalwart. Follow Amar Raganti. He's at Amar. Araganti. Follow our producers, Carmen Rodriguez at Carmen Armin dash Bennett at dash Bennett and Kale Brooks at Kail Brooks. Thank you to our producer, Moses, Ondom. And for more odd lots content, go to Bloomberg.com slash oddlots where we have transcripts, a blog, and a newsletter. And you can

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