Earlier this week, the Treasury released its quarterly update about its borrowing requirements and its strategy for meeting them. I haven’t had time to review all the documents, but I did skim through the minutes of the meeting of the Treasury Borrowing Advisory Committee (TBAC), which was held on November 3.
This pair of paragraphs particularly caught my attention (my emphasis added):
The Committee then turned to a presentation by one of its members on the likely form of the Federal Reserve’s exit strategy and the implications for the Treasury’s borrowing program resulting from that strategy.
The presenting member began by noting the importance of the exit strategy for financial markets and fiscal authorities. It was noted that the near-zero interest rates driven by current Federal Reserve policy was pushing many financial entities such as pension funds, insurance companies, and endowments further out on the yield curve into longer-dated, riskier asset classes to earn incremental yield. Treasury securities have benefitted from the resultant increase in demand, but riskier assets have benefitted even more. According to the member, the greater decline in the indices for investment grade and high-yield corporate debt relative to 10-year Treasuries and current coupon mortgages display this reach for yield. A critical issue will be the impact on the riskier asset classes as market interest rates move away from zero.
Yes, our old friend the reach for yield. Back in pre-crisis days, the reach for yield would often be viewed as evidence that the monetary transmission mechanism was working well, with low short-term rates providing a real boost to the economy. Now, however, we are all-too-familiar with the downside of the reach for yield: unsustainable booms in longer-term assets.
Is this deja vu all over again? I don’t know. But those paragraphs certainly didn’t make me feel more comfortable about our recovery.
P.S. I should also note that the TBAC endorsed greater reliance on Treasury Inflation Protected Securities (TIPS), as well as moving from 20-year TIPS to 30-year TIPS. These recommendations paralleled some similar ones released back in September by the GAO.