“When the ducks quack, feed them” — Wall Street proverb
In 2001, the U.S. Treasury decided to stop issuing 30-year bonds. The budget surplus made the long bond unnecessary and the new tax cuts were going to generate faster growth and abundant revenue.
It didn’t quite work out that way. Revenue fell, revealing a flaw in supply-side economic theory. The tax cuts didn’t pay for themselves, as their advocates had promised.
Then came the Iraq and Afghanistan wars, followed by the financial crisis. Pretty soon, it was apparent to anyone paying attention that the days of budget surpluses were long gone. Deficits had come to define the U.S. budgets.
Even with the U.S.’s huge funding needs, interest rates headed lower. The hunger for U.S. Treasuries remains unsated, so much so that today we seem to be facing a shortage of long bonds.
Here is a simple equation: Demand for Treasuries + ultra-low rates + big and persistent U.S. funding needs = the long bond.
If we were smart — and all indications are that as a nation, we’re not especially astute in our financial decisions — we would introduce a 50-year Treasury bond. Other nations have done so, most recently Canada.
Consider the reasons why:
1. Regardless of your views on debt and deficits, the U.S. has plenty of both. The long bond is a responsible way to address this, and to satisfy investor demand. You have to make hay when the sun is shining, and we have no idea how long this window will remain open.
2. Rates, although higher than their lows of last year, are still well below their long-term medians. Reissuance of long-term bonds allows the U.S. to take full advantage of this.
3. We may be at a generational selling opportunity for bonds. James O’Shaugnessy of O’Shaugnessy Asset Management has crunched the numbers, and he reaches the conclusion that low rates are unlikely to continue. The bull market in bonds, which began in the 1980s, is “3½ Standard Deviations above the long-term average for the bond,” based on rolling 40-year returns from 1900-2013 (see paper here).
4. The U.S. now funds long-term obligations with shorter-term financing. If we learned anything during the credit crisis, this is a recipe for disaster. Bringing the length of financing into closer alignment with our obligations simply is good financial stewardship.
5. The private sector is showing the way: Fixed-income investors have been lining up to purchase 30-year bonds from Bank of America, Apple, IBM, General Electric, Wal-Mart, Novartis, Pemex and others. Financial firms such as Morgan Stanley and JPMorgan Chase have been issuing perpetual notes with a fixed rate for 10 years, which then become Libor-plus bonds.
As we have seen, courtesy of the trouble in Ukraine, the U.S. remains the safe harbor when turmoil appears anywhere in the world. We have the world’s reserve currency, a simple fact that is unlikely to change any time soon. Perhaps most of all, there is a massive demand for Treasuries of all maturities. We would be foolish if we failed to respond to this market demand.
It’s time to feed the ducks.