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Playing the Long Game—Should the US Treasury Issue Ultra-Long Bonds?

Cambridge Associates

Alex Pekker

Jeff Blazek

Answers to our clients’ questions about market action and the market environment in a few paragraphs every two weeks.

Yes. Issuance of ultra-long Treasury bonds (greater than 30 years to maturity, including potentially 40-, 50-, and 100-year maturities) would benefit multiple constituents. Ultra-long Treasuries would extend the investable Treasury curve for pension plans and life insurance companies that hedge long-duration liabilities. In addition, they would enhance the credit markets by improving price discovery for ultra-long credit already issued and held by investors. Finally, if well executed, ultra-long issuance could lock in low-cost government financing for a very long time. (Admittedly, this last item is beyond the scope of this piece, but would be of paramount concern to all taxpayers!)

The Treasury Department recently announced it is evaluating issuing ultra-long bonds. In early May, the Treasury Borrowing Advisory Committee (TBAC), representing primarily large bond-trading firms, outlined potential headwinds to ultra-long bond issuance, including uncertainty around the sustainability of institutional demand and potentially high issuance costs. Although TBAC raises relevant questions on how well these bonds would be received, the demand for and cost of ultra-long bonds will ultimately be dictated by how much the Treasury issues relative to investor appetite. If managed in line with investor demand, we view the creation of a Treasury market beyond 30 years favorably, as it would benefit both US investment-grade bond markets and investors.

We believe significant interest for ultra-long Treasuries would be generated by pensions and insurance companies, as institutional investors that hold multiple trillions of assets are natural long-term buyers of long paper. Many defined benefit pension plans have benefit payment streams that extend well beyond 30 years. Each plan is unique, but some open plans may have liability durations (interest rate sensitivities) as high as 16 to 20 years. For most pension plans, roughly 15%–40% of the projected benefit payments in future value terms (and 5%–20% in present value) occur at least 30 years into the future. Hedging such interest rate risk to date has required the use of STRIPS and derivatives. Ultra-long Treasuries would be an additional tool for hedging long liabilities, and could be particularly attractive to plan sponsors who either cannot (due to investment resource constraints) or choose not to use derivatives. Moreover, life insurance companies are increasingly acquiring long-duration liabilities through pension risk transfers. Although most insurance companies back these and other liabilities primarily with corporate bonds, ultra-long Treasuries would be another tool for hedging these liabilities.

It is worth noting that several corporate, quasi-governmental, and foreign bond issuers have already taken advantage of both the low-yield environment and pension demand for ultra-long bonds. Currently, more than 100 US investment-grade bonds (reflecting 70 issuers and approximately $110 billion market value) with over 30 years to maturity have been issued; 16 of these have over 50 years to maturity. Unfortunately, these ultra-long credits are being sub-optimally priced based on the 30-year Treasury, which is problematic given differences in maturity and creates ambiguity in the term structure of credit spreads. The issuance of ultra-long Treasuries would bring transparency to pricing these ultra-long credits, also likely reducing frictional trading costs. In a similar fashion, pricing for long-dated interest rate swaps could be improved. Finally, pension discount rates and liability risk transfer pricing could also more accurately reflect available hedging securities beyond 30 years.

Interestingly, the duration of a 50- or a 100-year coupon-paying Treasury bond is only marginally higher than that of 30-year STRIPS, which some might argue obviates the need for ultra-long bonds. However, the cash flow, convexity, and key-rate duration characteristics of ultra-long bonds are quite different, making ultra-long bonds and STRIPS complementary, rather than interchangeable. Moreover, just like other Treasuries, ultra-long bonds could be stripped, producing 50- and 100-year duration zero-coupon bonds and stripped coupons.

As the Treasury gathers feedback from other constituencies, we would expect some reaction in existing Treasuries—as the market adjusts its expectations for supply. If the Treasury does decide to include ultra-long bonds in its issuance toolkit, deciding how much to issue relative to traditional maturities will be important to balancing the government’s financing needs with interest rate stability.

Originally published on May 23, 2017

Jeff Blazek is a Managing Director and Alex Pekker is a Senior Investment Director in Cambridge Associates’ Pension Practice.

The authors published a related article for Pensions & Investments’ Industry Voices on July 5, 2017. Read the contributed commentary, Playing the long game: The case for ultralong Treasuries, here.

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