Prices of Treasury coupon securities have erased some of the outsized losses which resulted from the announcement of the Treasury plan to bailout the financial system with the purchase of illiquid assets from the portfolios of financial institutions. The plan reduced safe have demand for Treasury debt and also raised the specter of huge sales of debt by the Treasury to finance the proposed endeavor.In overnight trading the yield on the 2 year note has tumbled 7 basis points to 2.10 percent. The yield on the 5 year note has slipped 6 basis points lower to 2.98 percent. The yield on the 10 year note has edged lower by 3 basis points to 3.78 percent. The yield on the Long Bond has actually edged higher by 2 basis points to 4.40 percent.
The motivating force in the market throughout this week will be the formulation of a legislative package to implement the proposal submitted by the US Treasury. The Treasury and the Administration will aim to keep the legislation austere and unadorned while some lawmakers with misgivings may feel compelled to add provisions of their own.
There are several topics which will provoke serious debates. The Democrats and some Republicans seem intent on proposing some sort of salary cap for executives of companies which participate in the program. The Administration opposes these efforts as it believes that passage of such a provision would cause some firms to opt out of the program which would make it less effective.
There is another debate raging about accountability. Early drafts of the plan would establish the Secretary of the Treasury as Economic Czar and master of the universe in all matters pertaining to the purchase of mortgage assets. One version of the bill would make his decisions and actions “non reviewable” by any court or Administrative agency.
To give any man that wide a swath and discretion over a $700 billion program seems unconscionable. Some Democrats have proposed carving out a role for Congressional watchdog agency, the General Accounting Agency which would seem to be a very worthwhile addition to the bill.
Other lawmakers want to aid homeowners who face foreclosure. One article raised the interesting point that such an action would put the Treasury in a dichotomous position as actions to reduce homeowner liability would reduce the value of the mortgage portfolio as individual loan balances are reduced.
Finally, some lawmakers want to attach some economic stimulus to this package with provisions to create jobs and other provisions to extend unemployment benefits.
This will be a contentious discussion in the middle of a hotly contested Presidential race. I think a bill will emerge quickly and the major change will be increased oversight by the Congress. I think that other goals can be achieved later with passage of a different bill.
I do not have a strong feel for Treasury bond prices in the short run. We have backed up so much that some buyers will certainly emerge. However, there is a heavy spate of Treasury issuance this week which should serve to cap any strong advance.
In the longer run it is very difficult to posit sharp gains for Treasuries. The Treasury market is about to become a growth industry again. When the bailout bill passes, issuance from the Treasury will increase across the board. The burden of supply will lead to higher rates as investor appetite for Treasury debt will rapidly wane.
I am also fearful that the combination of increased issuance and a loss of confidence in the US will lead foreign investors to restrain their purchases of Treasury paper. I think that we are in for a rocky road ahead.
Originally published at Across the Curve and reproduced here with the author’s permission.