Treasury Borrowing Advisory Committee

Quarterly Refunding May 4, 2004

Portfolio Composition
We are introducing both 5-year and 20-year TIPS. We will need to reduce nominal issuance to make room for additional TIPS issuance. In the absence of liquidity concerns, we would eliminate the reopenings of 10-year nominal securities to accommodate the new securities. We would like the Committee’s views on eliminating the 10-year reopening, simply reducing the sizes of 10-year auctions, or spreading the reduction in issuance across both 5-year and 10-year issuance. In discussing these options, we would like the Committee’s views on the timing of implementation of the Committee’s preferred option. We would also like the Committee’s view on initial auction sizes for these new TIPS offerings and the appropriate position for 2 these securities in the issuance calendar.

Treasury Financing Requirements
($ Billions) January - March 2004
(Projected) (Actuals)

April - June 2004
(Projected)

Deficit Funding (Def + / Surplus -) Means of Financing Change in Cash Balance Net Non-Marketable Financing Net Marketable Financing Other* Net Marketable Financing Bills Nominal Notes TIPS Bonds
Notes: Starting Cash Balance Ending Cash Balance

203

171

22

13 5 177 8 177

12 7 146 7 146 56 78 12 0

-24 6 38 2 38

33 20

33 21

21 45

* Includes direct loan activity, changes in accrued interest and checks outstanding and minor miscellaneous transactions. Note: Totals may not add due to rounding

3

Financing Residuals Given Current Issuance Calendar
Assumes current coupon issuance pattern and issuance amount-- Bill issuance at levels required to maintain outstanding FY $ amounts nearly equal to September 30, 2003 total outstanding 600 $ billions 500 Forecast plus Avg. Absolute Error 600 $ billions 500

400 Forecast of Net Financing Needs 300 Forecast minus Avg. Absolute Error

400

300

200

200

100

100

0

0

-100 Bars Indicate Estimated Additional Financing Required In Given Year For Different Net Financing Needs 2004 2005 2006 Fiscal Year 2007 2008 2009

-100

-200

-200

-300

-300

*Chart does not include new 5-yr TIPS and 20-yr TIPS.

4

** Forecast of net financing needs is composed of Treasury’s announced estimate for FY ’04 and OMB projections for out years.

Starting Assumption: Percentage Breakdown of Issuance Constant
Distribution of Treasury's Marketable Debt Issuance
80%
projections

80% 70% 60% 50% 40% 30% 20% 10% 0% 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 calendar year BILLS 2-3 YR NOTES 4-7 YR NOTES 8-10 YR NOTES BONDS TIPS

70% 60% 50% 40% 30% 20% 10% 0% 1980

* Annual issuance is defined as all coupon issuance plus bills outstanding at the end of the period.

5

Projected Net Marketable Borrowing and Hypothetical Auction Sizes
Hypothetical Auction Sizes Include Amounts Awarded to the Federal Reserve auction sizes 50 $ billions 45 40 35 30 25 20 15 10 5 0 2004 BILLS 2-YEAR 2005 3-YEAR 2006 5-YEAR 10-YEAR 2007 5-YEAR TIPS 2008 10-YEAR TIPS 2009 TIPS BONDS Net Marketable Borrowing (RHS) net borrowing 500 $ billions 450 400 350 300 250 200 150 100 50 0

*Average auction sizes for nominal 10-yr calculated for 7 auctions in '04 and 4 per year after that; for 5-yr and 20-yr TIPS, average auction sizes are calculated assuming 2 auctions per year each (but only one 20-yr TIPS auction in FY 2004). **For bills, the average auction size equals the amount outstanding at the end of the fiscal year divided by 43 (i.e., 4 1-month auctions, 13 3-month auctions, plus 26 6-month auctions). 6 ***Based on assumptions in chart 5.

Distribution of Treasury's Marketable Debt
35% 35%

30%

30%

25%

25%

20%

20%

15%

15%

10%

10%

5%

projections '04 - '09

5%

0% 1980

0% 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 end of fiscal year BILLS 2-3 YR NOTES 4-7 YR NOTES 8-10 YR NOTES BONDS TIPS

*Based on assumptions in chart 5.

7

Current Projected Change in Debt Portfolio Composition Over Next 5 Years
30% 30%

25%

April 30, 2004 September 30, 2009

25%

20%

20%

15%

15%

10%

10%

5%

5%

0% Bills 2-year 3-year 5-year 10-year Nominal Bonds TIPS

0%

*Based on assumptions in chart 5.

8

Annual Issuance as a Percentage of GDP
21%
21%

19%

19%

17%

17%

15%

15%

13%

13%

11%

11%

9%

9%

7% 1980

7%

1982

1984

1986

1988

1990

1992

1994

1996

1998

2000

2002

2004

2006

2008

calendar year

* Assumes nominal GDP grows at 5% annually.

**Based on assumptions in chart 5.

9

Percentage of Debt Maturing in Next 12 to 36 Months
75% 70% 65% 60% 55% Maturing in 24 Months 50% 45% Maturing in 12 Months 40% 35%
projections '04 - '09

75% 70% Maturing in 36 Months 65% 60% 55% 50% 45% 40% 35% 30% 25% 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 calendar year

30% 25% 1980

*Based on assumptions in chart 5.

10

Financing Uncertainty and Interest Rate Volatility
As a follow up to discussions regarding the uncertainty of the budget-modeling process, we will show the Committee some charts illustrating the financing risk due to technical errors in budget forecasting. We will also show the Committee charts illustrating the trade-offs between interest costs and expected volatility. We would like the Committee’s views on Treasury’s tolerance for interest rate volatility.

11

Components of the Change in CBO's Budget Projection Since 2001
1000 $ billions 1000 $ billions

800 January 2001 Baseline Budget Forecast

800

Surplus

600

Revenues Debt Service Due to Changes in Legislation

600

400

400

200

Spending

200

0
Technical Errors

0

Deficit

-200

Economic

-200

-400
FY '02 and FY '03 Realized Deficits

-400 March 2004 Baseline Budget Forecast 2004 2005 2006 2007 fiscal year 2008 2009 2010 -600 2011

-600 2002

2003

12

Confidence Intervals Around CBO's Baseline Projection
(Probability distribution is derived from past projection errors during 1982 - 2002) $ 600 billions 400 200 0 -200 -400 -600 -800 -1000 -1200 2003 Approximate Contributions to Forecast Uncertainty Economic Variables: 35% Technical Errors: 65% Legislative Changes: N/A Baseline Budget Projection 75% Confidence Interval 95% Confidence Interval 200 0 -200 -400 -600 -800 -1000 -1200 2009 600 $ billions 400

2004

2005

2006
fiscal year

2007

2008

13

Analyzing Cost/Volatility Trade-off
• Annual change in interest costs is a function of…
– Factors not controlled by debt managers
• Deficit • Current Interest Rates and Inflation • Interest Rates on Maturing Debt

– Factors controlled by debt managers
• Amount of Debt Maturing • Distribution of Issuance

• Would a mean-variance framework help us make better debt management decisions?
14

Interest Expenditures under Various Financing Strategies
Inflation Adjusted to 2003 $Dollars Using GDP Deflator 450 $ billions 400 350 300 250 200 150 100 50 0 1960 1965 1970 1975 1980 1985 1990 1995 2000 Actual: Net Interest Short: All Deficits Financed with 3-Month Bill Long: All Deficits Financed with 20-Year Bond 350 300 250 200 150 100 50 0 450 $ billions 400

15

Self-Imposed Constraints
• Not market timers -- auction schedule fixed • Constraints on adjusting issuance sizes • Most securities can not be called early • Limits on the amount of cash we can hold

16

What Measures to Use in a Mean-Variance Analysis?
• Portfolio
– Debt Outstanding or Issuance

• Cost Measure
– Current or Historical Interest Rates – Current or Historical Spreads

• Volatility Measure
– Change in the Cost of Debt Outstanding or Interest Rates – Need to incorporate the different rollover characteristics and payment streams of various securities to measure the volatility of interest expenses on the debt outstanding
17

November Calendar
The November refunding calendar is complicated by several potential market-moving events and Veterans Day. We would like the Committee’s advice on the scheduling of auctions in the final quarter of this year.

18

Calendar Options for November 2004
Option 1:Keep announcement the same but auction 3y on Monday, 5y on Tuesday, and the 10y on Friday
Monday 1 2 Tuesday 3 Wednesday 4 Thursday 5 Friday

Election day/TBAC

ANNOUNCEMENT

Employment Report

8

9

10

11

12

AUCTION 3-YEAR NOTE 3/

AUCTION 5-YEAR NOTE 3/

FOMC

Holiday

AUCTION 10-YEAR NOTE 3/

Option 2:Keep announcement the same but auction 3y on Friday, 5y on Monday, and 10y on Tuesday
Monday 1 2 Tuesday 3 Wednesday 4 Thursday 5 Friday

Employment Report Election day/TBAC ANNOUNCEMENT AUCTION 3-YEAR NOTE 3/

8

9

10

11

12

AUCTION 5-YEAR NOTE 3/

AUCTION 10-YEAR NOTE 3/

FOMC

Holiday

Option 3:Keep announcement the same but auction 3y on Monday, 5y on Tuesday, and 10y on Wednesday after the FOMC meeting
Monday 1 2 Tuesday 3 Wednesday 4 Thursday 5 Friday

Election day/TBAC

ANNOUNCEMENT

Employment Report

8

9

10

11

12

FOMC AUCTION 3-YEAR NOTE 3/ AUCTION 5-YEAR NOTE 3/ AUCTION 10-YEAR NOTE 3/ Holiday

19
3/ Settles Nov 15.