Dazed and Confused

Let's say that you just decided to move to a much bigger house because your family grew. Your income pretty much was reduced because of company cutbacks, but instead of needing a six room house, you now needed an 11 room house.

You looked at five and ten year financing rates. The rates were pretty much the same. And if you tried to pay back everything you paid for your house in five years, your payments would be huge. They's be much more spread out if you paid them in ten years. And best of all, if you could stretch it out even longer, then the better. A 30 year debt instrument would be far better...and in a flat but low interest rate environment, the payment premium to the five year note would be non existent. But the PAYMENTS would be lower on a period to period basis.

The treasury, by doing this, is effectively "stretching out" the payments that it is making for US government debt, but doing it at bargain prices for the government. In financial parlance, the treasury is increasing its "average duration", i.e., balancing it's payments with the cash flows.

To the US Treasury, its cash flow is dependent upon tax receipts. It's debt is paid by issuing IOU's in the form of government paper, i.e, bonds notes, bills, repos, etc. Stretching out the duration is brilliant.

Sorry folks, if you hate the Bush administration, the truth is that this is a SMART policy. The fact is that the treasury is playing the yield curve like a fiddle. The dollar is low right now and so are rates. And the yield curve is flat.

Like the homeowner with steady income but huge debt, the government after '01 was in a huge slowdown. And it had the war to pay for. So the prudent thing to do was to finance the debt by reducing average payment and locking in low long term rates.

And to the Chicago trading community, beer glasses are clanking and maybe even champagne is being downed this evening..... It means new life for the long bond futures and options contracts at the Chicago Board and HUGE institutional business.