Surplus Isn’t Stopping Sales of New Debt

The U.S. Treasury is swimming in cash from the record federal budget surplus, yet Uncle Sam still is paying the highest yields in almost 10 years on three-month T-bills.

Meanwhile, the Treasury will be coming to market this week with $20 billion in new five-year and 9 3/4-year notes.

How can the United States have a surplus, yet still be selling so much new debt? And is this a good time for investors to be considering Treasury securities for their portfolios?

The simple reason the Treasury continues to issue new debt is that bills, notes and bonds issued in years past--when the government ran massive deficits--continue to mature on regular basis.

Although the budget is in surplus now, it isn’t enough to suddenly retire all of the $3.5 trillion in remaining public debt.

Hence, the Treasury continues to hold regular auctions of new securities to roll over some of the outstanding debt.

Yet those auctions are, in fact, shrinking--at least for many Treasury issues. And that has helped push yields down on those issues, in part because of their perceived scarcity factor in the long run.

At the same time, the Treasury’s decision to borrow more heavily via three- and six-month bills this year has pushed yields on those securities higher. With the supply of bills rising, the government is paying more to get investors to buy them.

That is most pronounced in the case of the three-month T-bill.

At the regular weekly auction of three- and six-month bills Monday (the Treasury officially calls them 13-week and 26-week bills), the government sold $11 billion in three-month bills at a discount rate of 6.22%, up from 6.18% last week.

That was the highest auction rate since Jan. 7, 1991, when new bills sold for 6.52%.

The discount rate--which reflects that T-bills are sold at discounts to their $1,000 face value, then redeemed for the full $1,000 by the Treasury at maturity--understates the annualized yield on the notes.

On the three-month bills sold Monday, that true yield was an annualized 6.41%.

The Treasury also sold $10 billion of six-month bills Monday at a discount rate of 6.11% and a true annualized yield of 6.39%. That’s the highest since late July.

For investors looking to lock in attractive yields on short-term securities, Treasury bills have appeal now, experts note.

Not only are the yields relatively high, but the interest isn’t subject to state income tax (though it is subject to federal income tax).

Until 1998, it took a minimum of $10,000 to buy a T-bill. That minimum is now just $1,000. What’s more, investors can easily buy Treasury securities directly from the government, at no fee.

For more information on the Internet, go to https://www.publicdebt.treas.gov/sec/sec.htm.

To order T-bill forms from the Los Angeles branch of the San Francisco Federal Reserve Bank, call (213) 624-7398.

You also can use that phone number to get forms for other Treasury security auctions.

This week, the government will hold auctions of two longer-term securities:

* Today, the Treasury will sell $12 billion of five-year notes. On Monday, the most recently issued five-year note had a yield of about 5.90%.

* On Wednesday, the Treasury will sell $8 billion in 9 3/4-year notes. The last such security auctioned now has a yield of about 5.84%.

As with T-bills, interest on Treasury notes is subject to federal income tax but not state income tax. The minimum note investment is $1,000.

Yields on current five-year and 10-year notes are lower than yields on T-bills, in part because of expectations that fewer longer-term securities will be in the market in coming years, and also because of expectations that the economy is slowing.

The market, analysts say, is betting that the economy will slow enough to eventually prod the Federal Reserve to bring down short-term interest rates, which it controls.

Why buy a longer-term T-note that pays less than a short-term T-bill? If you believe the economy will slow significantly, T-bill yields could drop sharply in the next year. That could mean that locking in a longer-term yield now would be a smart move.

But the election is a wild card, analysts note: An election outcome that triggers fears of a stronger economy ahead could push up long- and short-term yields alike.

Meanwhile, one Treasury security seems doomed for extinction: The one-year T-bill.

The Treasury is hoping to eliminate auctions of the one-year bill altogether, provided Congress acts soon to make that possible.

“I am pleased to report that we will have made significant progress” in getting Congress to act on this proposal, Gary Gensler, Treasury undersecretary for domestic finance, said last week.

The Treasury already has limited sales of one-year bills to quarterly from monthly.

Treasury officials have discussed their options with Congress because the one-year bill is specified by law as the benchmark used to set interest rates for student loans and other borrowing costs.

All in all, the recurring federal surpluses have allowed the Treasury to pay down billions of dollars of its publicly traded debt and buy back outstanding securities for the first time in 70 years.

Since March, the government has purchased more than $25 billion in bonds. The Treasury last week said it would buy back $9 billion in securities during the first quarter of next year.

“As a result of three years of budget surpluses, we have paid down $363 billion of publicly held debt,” Gensler said. “This truly has been a remarkable period for Treasury debt management.”

The United States recorded a $237-billion surplus for fiscal 2000, which ended Sept. 30. The Congressional Budget Office has projected a $268-billion surplus for this year and a $4.6-trillion budget surplus over the next 10 years.

“The past seven years also marks the longest series of consecutive years of fiscal improvement in American history,” Gensler said. As a result, “our publicly held debt now stands at just 34% of gross domestic product, down from nearly 50% at the start of the administration.”

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Towering T-Bill Yields

The annualized yield on $11 billion in three-month U.S. Treasury bills auctioned on Monday was 6.41%, the highest since Jan. 7, 1991, the Treasury said. The

T-bill yield has been surging recently in large part because the government is borrowing more via short-term securities and less via longer-term securities.

Quarterly closes and latest yield on three-month U.S. Treasury bills

Monday: 6.41%

Source: Bloomberg News