The Treasury Securities Market: Overview and Recent Developments

Federal Reserve Bulletin, Dec, 1999 by Dominique Dupont, Brian Sack, Emilie Archambeault

Dominique Dupont and Brian Sack, of the Board's Division of Monetary Affairs, prepared this article. Emilie Archambeault provided research assistance.

The market for U.S. Treasury securities is by many measures the largest, most active debt market in the world. At the end of September 1999, the amount of Treasury debt held outside federal government accounts totaled about $3.6 trillion, close to the amount of outstanding debt securities issued by all U.S. corporations combined.(1) Moreover, enormous amounts of Treasury securities are traded every business day. Over the first nine months of 1999, the primary dealers in government securities, which are among the most active participants in the market, together executed an average of $190 billion worth of transactions in the securities each day.(2)

The heavy trading is an indication of the pivotal role of U.S. Treasury securities in world financial markets. Investors of many types--commercial banks, investment banks, money market funds, insurance companies, individual investors, and foreign central banks, among others--use the Treasury market for investing and hedging purposes. Yields on the securities are widely viewed as benchmarks in the pricing of other debt securities and are analyzed for the information they might reveal about market participants' expectations about the future path of the economy and monetary policy.'

This article begins with a description of the structure of the Treasury market, including the process by which securities are issued in the primary market and the mechanics of the secondary market. The determinants of investor demand for Treasury securities are then discussed in some detail. The article concludes with a discussion of several recent developments and emergent trends that have affected the market, including the advent of inflation-indexed securities, a reduction in the issuance of Treasury securities, and shifts toward electronic trading and alternative clearing arrangements.

OVERVIEW OF THE MARKET

The market for U.S. Treasury securities has a complex structure and involves numerous participants-the Department of the Treasury, the Federal Reserve System, government securities dealers and brokers, and other holders of Treasury securities.

Scope of the Market

The federal government finances its expenditures in excess of tax receipts through the sale of debt obligations. Over the years, the Congress has delegated to the Department of the Treasury its authority under the Constitution to issue debt securities. The United States, initially as the Continental Congress, first incurred debt in 1776 when it borrowed funds to finance the Revolutionary War.(3) Total Treasury debt remained fairly small in the first half of the nineteenth century but rose sharply with the Civil War and again with World War I (chart 1). After declining slightly, the debt increased nearly threefold during the Great Depression and exploded in the 1940s as the government financed expenditures related to World War II. From its postwar low in 1949, outstanding Treasury debt grew gradually for nearly two decades before accelerating at the time of the Vietnam War and during the subsequent period of high inflation. In the 1980s, the growth of the stock of debt picked up further, spurred by the tax cuts and rapid increases in defense spending of the decade.

[Chart 1 ILLUSTRATION OMITTED]

In recent years, budget surpluses have halted the upward climb in the total amount of Treasury debt held outside government accounts. However, the overall magnitude of outstanding debt remains substantial, a legacy of past budget deficits. At the end of September 1999, the total par value of outstanding Treasury debt, including that held in government accounts, stood at about $5.6 trillion, or about 61 percent of the total annual output of the economy. This fraction, though considerable, is well below the peak after World War II (chart 2).

[Chart 2 ILLUSTRATION OMITTED]

Types of Treasury Securities

Of the $5.6 trillion in outstanding debt at the end of September 1999, about $3.2 trillion was in the form of marketable securities--instruments that may be traded after their initial purchase. These securities are the focus of this article. New marketable securities are regularly offered in maturities ranging from thirteen weeks to thirty years. Bills--securities having a maturity of one year or less--sell at a discount from their face value (par) and do not pay interest before maturity. Investors realize a return on bills from the increase in their price to face value at maturity. Notes--securities having an initial maturity of one to ten years--and bonds--securities having an initial maturity of more than ten years--offer investors semiannual interest payments, or coupons.

More than half the marketable Treasury debt outstanding is in the form of notes, while bills and bonds each represent about 20 percent (chart 3). Some of the outstanding bonds are callable securities, which may be redeemed by the Treasury before their maturity; however, only noncallable securities have been issued since 1985. Most of the marketable debt outstanding (about 97 percent) is in the form of nominal securities--securities for which the coupon and principal payments are fixed in dollar terms. Since 1997, the Treasury has also issued securities whose coupon and principal payments are indexed to the rate of inflation. (The indexed-securities program is described later in the section "Availability of a New Instrument.")