Monday, October 27, 2008

Size of upcoming Treasury auction not an issue

This morning I watched CNBC market commentator, Rick Santelli, talk about the upcoming supply of new Treasuries that are about to be auctioned off. His concern was the size of the supply and what impact it could have on prices and rates, as if to suggest that buying all these new bills, notes and bonds will put a strain on investors’ cash. What Santelli and many others fail to realize is that the Fed has already put more than $2 trillion into the banking system, meaning that the $100 billion or so of new supply will be readily absorbed with little trouble. Moreover, the interest rate on most of these securities is far higher than the interest rate the Fed pays on reserve balances (currently, about 1.15 percent), meaning that there is a good economic incentive to buy them. In essence, this is simply a swap that replaces a low yielding reserve balance for a higher yielding Treasury security.

***Remember: the funds that are used to buy Government securities (and pay taxes) come from Government spending. The money is put into the banking system first, ensuring that there is always an ample amount to buy the securities.

It is also why supply does not affect interest rates. Rates are set by the central bank.

No comments: