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

Accordingly, since the summer of 1999, the Fed has used Fannie Mae and Freddie Mac mortgage-backed securities in its open market operations, and Fed officials recently decided to continue this practice through early 2001. But at the March 21, 2000 FOMC meeting, Fed authorities suggested that the use of these government-chartered agency securities in open market operations might be temporary. Specifically, in a none-too-subtle hint of displeasure with the elevation of these agency securities to benchmark status, Fed officials noted that the current use of Fannie Mae and Freddie Mac securities in open market operations "should not he read as indicating in any way how the [Fed] might ultimately choose to allocate the portfolio" used in the future conduct of open market operations. In a March 10, 2000 letter to Congressman Spencer Bachus (R-Alabama), Greenspan observed, in a similar vein, that "...the capital markets would create alternative benchmarks to fill the void left by disappearing Treasury debt." He add ed that "Fannie Mae and Freddie Mac already have attempted to take advantage of this situation by issuing so-called 'benchmark' and 'reference' issues, but it is possible that obligations of entirely private firms eventually could serve as benchmarks". More recently, in a May 19, 2000 letter to Congressman Richard Baker (R-Louisiana), author of the Baker bill, Greenspan noted that these housing-related government-sponsored enterprises- initially established as federal government entities to carry out specific government policies--have, despite their subsequent privatization, continued to hold a special status in the eyes of many investors. He went on to warn that to the extent these government-sponsored enterprises alter housing finance by passing part of their government subsidy through to homebuyers, they "divert real resources from other market-determined uses."

Best Benchmark is Market-Determined

In the final analysis, as Greenspan has observed, the capital markets themselves should come up with the best new benchmark to replace contracting Treasury issues. The market-determined choice seems to be found not in the public sector's agency issues, with their uncertain implicit government guarantee, but in the private sector's dollar swap rate. The dollar swap rate has been the benchmark for pricing fixed-income securities in Europe for a number of years, and it is now catching on in the U.S. This rate is determined by dollar swap agreements, in which one party typically pays the LIBOR rate, which fluctuates daily, and the other party pays a rate that is fixed for the term of the agreement, routinely ranging anywhere from a few weeks to thirty years. Recently, Ford Motor, General Motors, and Wells Fargo have all used the dollar swap rate as the benchmark for debt issues. For example, on June 7, 2000 Ford Motor sold a hefty $4.5 billion in bonds using the swaps curve as the yardstick for pricing.

Currently, the interest-rate swaps market is very active, with quite narrow bid-ask spreads. A market survey by the Federal Reserve Bank of New York found daily trading in dollar swaps to be a substantial $22 billion per day in April 1, 1998, and it has undoubtedly grown since then. Turnover in dollar swaps is thus considerably higher than in agency coupon securities, though less than in Treasury securities.