Flight to Safety and U.S. Treasury Securities

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Flight to Safety and
U.S. Treasury Securities
By Bryan Noeth and Rajdeep Sengupta

                                                                                                                    photo used with permission from the Bureau of puBlic deBt

G     overnment debt of the United States
      is typically issued in the form of U.S.
Treasury securities. These securities—simply
                                                   issued, while the level of TIPS and T-bonds
                                                   has remained relatively unchanged.
                                                      In sum, financial markets have witnessed
                                                                                                      credit risk was primarily concentrated in the
                                                                                                      mortgage market.
                                                                                                         Nonetheless, the collapse of Lehman
called Treasuries—are widely regarded to           a significant increase in the supply of Treasur-   Brothers on Sept. 15, 2008, signaled the
be the safest investments because they lack        ies (level of debt issued by the government) in    beginning of a financial panic. Increased
significant default risk. Therefore, it is no      recent times (Figure 1).                           selling pressure by panic-stricken investors
surprise that investors turn to U.S. Treasur-                                                         lowered prices and raised yields on corporate
ies during times of increased uncertainty as       Interest Rate Response                             bonds (Figure 2). At the same time, inves-
a safe haven for their investments. This hap-         Interest rate activity after the mortgage       tors increased their demand for safer assets,
pened once again during the recent financial       crisis of 2007 also seems to provide evidence      namely U.S. Treasuries, and this led to a fur-
crisis. In fact, the increase in the demand for    that would suggest that investors found            ther decline in the yields on U.S. Treasuries.
Treasuries was sufficiently large so that prices   safety in U.S. Treasuries, especially T-bills.     Yields on short-term U.S. securities decreased
actually rose with an increase in the supply of    Figure 2 shows the yields on the three-month       sharply to near zero in November (Figure
government securities.                             and 10-year Treasuries, as well as those on        2). However, the movement in long-term
                                                   Moody’s Aaa and Baa corporate bonds.4 Cor-         Treasury yields was sluggish—hovering about
Supply of Government Securities                    porate bonds carry a risk that the corporation     4 percent before falling to about 2 percent in
   In the latter half of 2008, the Treasury auc-   issuing this debt security will default on its     December 2008. In part, this later decline
tioned a large amount of securities to cover       obligations. For taking this relatively higher     was also prompted by the Federal Reserve’s
the cost of the Emergency Economic Stabili-        risk, investors are rewarded with a higher         measures to buy long-term Treasuries under
zation Act.1 After the act was passed, hold-       yield than they would get if they had invested     its large-scale asset purchase programs.
ings of U.S. marketable Treasury securities        in long-term Treasuries. As seen in Figure 2,         In summary, there has been a large expan-
continued to increase over the next year and       there was no significant change in this differ-    sion in the amount of Treasury security
a half, from $4.9 trillion in August 2008 to       ence of yields (spread) before the onset of the    offerings while yields on Treasuries have
$7.4 trillion in February 2010. Figure 1 shows     current financial crisis.                          actually declined. Stated differently, the
the levels of short- and long-term securities         However, when the mortgage market               prices on Treasury securities have actually
outstanding from 2006 to 2009.                     began to slide in August 2007, yields on           increased in the face of a rapidly expanding
   Short-term securities are also known as         short-term Treasuries fell sharply. Although       supply of these securities. This anomalous
Treasury bills; they have maturity dates of less   the supply of Treasuries was relatively con-       behavior in the market for Treasuries can
than a year.2 In August 2008, approximately        stant in the second half of 2007 and the first     be explained by a significant increase in the
$1.2 trillion in T-bills was outstanding. By       half of 2008, yields on both short-term and        demand for Treasuries—“the flight to safety”
November 2008, that number ha
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