The Demise of the 30-Year Treasury Bond as a Benchmark or Pricing Fixe — Income Securities - Statistical Data Included

Business Economics, Oct, 2000 by David M. Jones

Crucial to this "crowding in" process was a macroeconomic policy-mix consisting of tight fiscal policy and relatively loose monetary policy. Other things being equal, this macroeconomic policy-mix produces a new full-employment equilibrium at lower real interest rates, thereby increasing the share of business investment and other interest-sensitive spending in relation to total "potential" output. Of course, today's rapid technological innovation stemming from the information technology revolution has also helped stimulate higher-than-usual business investment in information processing and telecommunications equipment. Thus, as Federal government financing demands on the capital markets lessened in the 1990s, corporate and housing-related agency borrowing mushroomed as the cost of capital declined and high-tech business investment and housing activity surged.

This "crowding in" of private sector corporate borrowing to fill the vacuum created by contracting Treasury borrowing has seen corporate issuance increase in sizes and regularity in order to appeal to investor demand for large, liquid issues. In particular, Ford Motor Company announced its Global Landmark Securities Program in June 1999, modeled on the borrowing programs of government-sponsored enterprises such as Fannie Mae and Freddie Mac. Under this program, which has been mirrored by other large finance companies, Ford and its financing subsidiary, Ford Motor Credit Company, announced that they would bring offerings of at least $3 billion to market two to four times per year. At this time, Ford had debt outstanding of $144 billion, compared with much higher agency totals of $500 billion for Fannie Mae, $437 billion for the Federal Home Loan Banks, and $314 billion for Freddie Mac. Liquidity of the large Ford issues is reportedly fairly good. However--in contrast with Treasury securities--there is no futu res market for Ford, or other corporate issues for that matter. Moreover, corporate issues are not actively traded in the repurchase (repo) market. Ideally, a new benchmark would have both a futures market and be actively traded in the repo market.

The bottom line is that "crowding in" and the resulting surge in corporate borrowing in support of high-tech investment is beneficial for increased productivity and future higher potential non-inflationary growth. But the problem is that persistent fiscal surpluses, although providing room for the "crowding in" of corporate borrowing, leaves shrinking Treasury issues a less attractive benchmark. While Treasuries remain free of default risk, the reduced market liquidity and efficiency that comes with their shrinking supply renders them less effective as benchmarks.

Substitute Benchmarks

A new benchmark for pricing fixed-income securities must, at a minimum, track closely with general fluctuations in market yields on other fixed-income issues, ranging from mortgage securities to high-yield corporate junk bonds (see Figure 2). To be sure, there may be times--such as the fall of 1998--when the tracking breaks down. In this period, the global financial crisis was at its peak: and massive deleveraging and a flight to safety caused yields on corporate bonds, swaps, mortgage-backed securities, and government-sponsored agency issues to spike higher relative to declining yields on risk-free, "safe-haven" Treasury issues. However, unlike the temporary shock of the fall of 1998, beginning in 2000 the linkage between Treasury yields and yields on private corporate and mortgage debt have diverged increasingly, as Treasury yields have been pushed lower mainly by contracting supply.