Market Mover - BNP PARIBAS - Investment Services India

This section is classified as non-objective researchUS: Treasury Quarterly Refunding Preview• The refunding announcement on 2November provides long-term guidance onTreasury issuance and the auction calendar.• Many investors have been expectingissuance cuts this year, due to Treasury’sprevious guidance. However, since BNPP hashad more pessimistic econ/budget forecasts,we have not expected issuance cuts any timesoon. This time is no different.• Is Treasury timing the market? They shortedthe long end two years ago. Now, they’reconsidering switching from fixed to floating!There are a range of budget forecasts that Treasurycan use when deciding how to manage the auctioncalendar. We show a few different forecasts in Table 1:- Baseline scenario: This comes from the CBO(Congressional Budget Office), and generally assumesthat current law remains in place. It also assumes thatthe Budget Super-Committee will follow through withidentifying USD 1.2tn in future savings.- Alternate scenario: Here, the CBO assumes thatmost of the Bush tax cuts are extended, the AMT isindexed for inflation (both political parties seeminglyfavour this), and a few other “likely-to-happen” factors.- Bloomberg median forecast: In the two scenariosabove, CBO assumes 3.6% GDP growth in the 2013-2016 period, along with a sharp decline in U/E from8.5% to 5.3%. Let’s face it, this is over-optimistic, sothe Street’s expectations provide a useful reality check.- Net Treasury issuance: This is how much money israised if auction sizes are left unchanged. In ouropinion, a prudent long-term financing strategy wouldbe to hold off on auction size cuts until 2013, based onthe comparison shown in Chart 1.Is Treasury timing the market?Two years ago, Treasury began to actively extend theduration of its issuance, so as to “lock in” historicallylow rates. Rates have not sold off as expected, so thecost of this strategy might be coming under scrutiny.After all, T-bill issuance has come down at the sametime. So, Treasury has switched from issuing bills at0.00% to issuing 10yrs and 30yrs at a greater cost (fornow). One sign that Treasury is looking to hedge thisstrategy is that it is exploring floating rate notes(FRNs), which reduce the cost of issuance when theyield curve is fairly steep.Table 1: Annual Budget Deficits (USD bn)2012 2013 2014CBO Baseline Scenario 970 510 270CBO Alternate Scenario 1,000 770 640Bloomberg Median Forecast 1,100 850 n/aNet Treasury Issuance (current path) 900 850 700Source: BNP Paribas. Figures rounded to nearest 10bn.201220132014Chart 1: Annual Budget Deficits (USD bn)0 200 400 600 800 1000 1200Source: BNP ParibasCBO Baseline ScenarioCBO Alternate ScenarioBloomberg Median ForecastNet Treasury Issuance (current path)There appears to beroom to cut issuanceonly in 2013Chart 2: Treasury Issuance Should Remain Steady3002502001501005002-3Y5-7Y10-30YQ1 06Q2 06Q3 06Q4 06Q1 07Q2 07Q3 07Q4 07Q1 08Q2 08Q3 08Q4 08Q1 09Q2 09Q3 09Q4 09Q1 10Q2 10Q3 10Q4 10Q1 11Q2 11Q3 11Q4 11Q1 12Q2 12Source: BNP ParibasForecastWe think the chances of actually seeing TreasuryissuedFRNs are quite low because there would haveto be compelling evidence that this reduces financingcosts. FRNs would surely attract additional buyers intothe market, as there is less interest rate risk. However,the big downside is that if Treasury's offerings arespread into more diverse products, then the liquidity inthose products goes down and can affect the ability ofdealers to effectively market these products.Suvrat Prakash 27 October 2011Market Mover30www.GlobalMarkets.bnpparibas.com