UST Supply Shortage

Brad Setser has an interesting post on the effect of treasury issuance on the shape of the yield curve.

At the end of 2001, ten year Treasury notes and even longer term Treasury bonds accounted for 40% of the total stock of marketable Treasuries, or $1168 billion of the $2915 billion stock (The relevant data can be found here, and here). At the end of fiscal 2004, the ten-year note and the remaining stock of even longer-term bonds constituted only 31% of the outstanding stock, or $1203 billion of the $3845 billion total.

In other words, the overall stock of Treasuries increased by $931 billion, and the stock of longer term Treasuries (ten years and up) increased by only $35 billion. If the percentage of longer-term Treasuries in the overall debt stock had stayed constant at the 2001 level, the current stock of longer-term treasuries in the market would be closer to $1540 billion than to $1200 billion ...

Increased issuance of inflation-indexed bonds (TIPS) is not the main explanation for the reduction in the supply of longer-term bonds. TIPS increased from 4.6% to 5.7% of the total stock over this period, while the stock of bills and 2-3 year notes rose from a bit over 38% of the stock to a bit over 49% ...

If even a small fraction of the $700 billion in foreign purchases of Treasuries since the end of 2001 (using data through September 2004) went into the ten year note or the long-bond, the stock of long-term Treasuries in American hands has gone down -- even though the overall stock of Treasury notes is way up. Given the overall surge the stock of marketable fixed income debt, there is no doubt that the stock of longer term Treasuries has fallen relative to the overall market for longer term fixed income assets.

I commented on his site that given the tightness of corporate spreads it is difficult for me to see the short supply of 10-year government paper as the cause for low yields on the long-end. I agree with the gist of his post that there is something artificial about the low 10-year yield in the face of rising short rates but I am not sure watching issuance patterns of the U.S. Treasury will help me figure out when the pattern will change.