E-piphany

The call apparently went out today for people to talk up how easy it will be for the US government to finance its huge 2011 deficit while rolling over maturing debt as well. The Wall Street Journal had a comment from an analyst at RBS who declared that “the days of steadily rising Treasury supply are likely behind us,” despite the fact that even a rudimentary calculation (which I ran through on Monday) argues vehemently otherwise. And later, Bloomberg joined the act in an article on the quarterly refunding announcement:

The U.S. plans to sell $81 billion in its quarterly sales of long-term debt next week, saying there’s no need for more increases in auction sizes to finance the country’s budget deficit. (Bloomberg, “U.S. Treasury to Sell $81 Billion in Long-Term Debt Next Week”, 2/3/2010)

The problem is that the Treasury did not in fact say that there was no need for more increases in auction sizes. What they said was (from the same article from Bloomberg!):

Treasury now believes that the current auction calendar provides debt managers with sufficient flexibility to address a range of expected borrowing needs,” said Matthew Rutherford, the Treasury’s deputy assistant secretary for federal finance, according to minutes of an advisory committee meeting yesterday. (Bloomberg, “U.S. Treasury to Sell $81 Billion in Long-Term Debt Next Week”, 2/3/2010)

Notice that nothing was said about the size of the issues on the calendar, just that the calendar itself – indicating which tenors will be auctioned, and when – is currently adequate. That’s not terribly surprising, at least on the nominal debt side. Treasury now auctions 1m, 3m, 6m, 12m, 2y, 3y, 5y, 7y, 10y, and 30y debt regularly. There aren’t a whole lot of points that even could be added! I suppose we could bring back the 4y note (lost in the early ’90s) or the 20y (last seen were the Feb ’06s, auctioned in 1986, I believe), and there is probably demand for some ultra-long notes. Existing issues could be auctioned more-frequently although currently 2y, 5y, 7y, and 10y notes are already auctioned monthly.

But there isn’t a lot of surprise, anyway, that the nominal calendar remains unchanged for now.

And even then, the Treasury is preparing to change the TIPS calendar. In a few weeks it will auction a new 30y TIPS bond, and they are considering adding two more 10y TIPS auctions (to make 6 per year: 2 new issues and 2 re-openings for each) as well as increasing auction sizes generally. This is welcome (and I still think they ought to bring an inflation-linked perpetuity to market). I had mentioned in a commentary in December that the failure of TIPS issuance to keep up with nominal issuance was a potentially disturbing sign. Increasing TIPS issuance will help the Treasury keep inflation expectations (and therefore, the yields at which they will sell the debt) lower than they would otherwise be.

While I don’t think there are very many paths left that do not lead to eventual monetization of the debt, and I suspect that policymakers are beginning to fear that as well, the amount of TIPS issued is still a pittance against the nominal float and won’t keep anyone from turning on the printing press if that is what they want to do. Besides, they need the money.

Tomorrow’s data includes the preliminary estimate of Q4 Nonfarm Productivity (Consensus: +6.5%) and Unit Labor Costs (Consensus: -3.4%). Assuming that the data are anywhere near to expectations, we will see the usual parade of people on CNBC, Bloomberg, and elsewhere proclaiming that inflation isn’t a problem and nothing to worry about since labor costs are declining. Ignore those people. Not only are the ULC data pretty useless in real time, since productivity estimates are revised literally for years, but also the connection between labor costs and inflation is pretty tenuous. There is no doubt that over time, the compensation for labor generally covaries with inflation…but there is very little evidence to suggest that changes in labor costs lead inflation. Indeed, unless you believe that workers have more power than capitalists, the causality makes more sense the other way – seeing inflation, workers harangue for higher wages. Either way, many years of history don’t make persuasive reading for the notion that lower ULC increases should cause fear of price pressures to abate. The chart below (Source: Bloomberg) shows the core CPI price level compared to Unit Labor Costs.

Soft Unit Labor Costs Will Not Lessen My Fear Of Inflation

More interesting, for my money, is Initial Claims (Consensus: 455K). Ordinarily, Claims from the day before Employment is not a market-mover and I don’t really expect this one will be either. But economists are still waiting for the retracement of the recent jump in filings caused, we think, by the clearing of the backlog in California. Every week that goes by without Claims dropping back down will cause projections of the employment trajectory to change. Still, with ADP today showing the best result in two years, any sign of weakness from Claims may be ignored.