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Bond market transformed by use of new yardstick

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The glory days of the 30-year U.S. Treasury bond may soon be over.
It has reigned for 20 years as the undisputed benchmark for the bond market. But now the 10-year Treasury note and other types of bonds are upstaging it, industry experts say, and the 30-year bond may one day be eliminated.
"The U.S. Treasury is in the process of making the 30-year obsolete," said Ward McCarthy, managing director of Stone McCarthy Research of Princeton, N.J. "I believe the Treasury eventually will just stop issuing 30-year debt, and that may happen next year."
The reach of the 30-year bond, commonly called the long bond, extends far beyond the small circle of bond traders - and touches average Americans on a variety of levels.
Home mortgage rates and other credit instruments are often tied to government bonds. Portfolio managers of bond mutual funds often measure their funds' performance against the so-called risk-free rate of the 30-year Treasury. And the long bond also is used as rough gauge of inflation.
If government bonds eventually disappear, some extremely safe corporate bond - such as those issued by Ford Motor Co. or IBM Corp. - would have to assume this yardstick role.
The long bond debuted in 1977 as a new federal tool to finance the government's operations. Almost immediately, it became a proxy for the rest of the bond market.
As government debt exploded in the 1980s, billions of dollars of long bonds were sold each year, creating "a highly liquid, active market," said Mr. McCarthy.
The financial press and, later, stock market television programs routinely reported the yield and price of the long bond, helping raise its profile.
Investors small and large snapped up the bonds, which carry face values stretching from $1,000 up into the millions. Perhaps more important, the bonds also began to change hands just like stocks. Today, the long bond is a heavyweight in a $14.7 trillion market for U.S. government debt.
By the late 1980s, the Treasury was auctioning more than $20 billion a year of long bonds. In 1991 it sold $46.8 billion worth, the most ever.
But in the mid-1990s tax revenues generated by the steaming U.S. economy fattened the government's coffers and lessened the need for borrowing.
And in 1999, the government actually recorded a budget surplus. It reduced its sale of 30-year bonds from $30 billion in 1998 to $20 billion last year. Bond experts expect the total to fall to about $15 billion this year.
By contrast, the Treasury Department expects to issue $35 billion in 10-year notes this year.

"The government has sharply curtailed the issuance of 30-year debt," said Mr. McCarthy. "But more than that, it has also started buying back debt from institutions and investors."

So far the government has bought back $7 billion, mostly in long bonds, and more is expected, according to Pete Hollenbach, spokesman for the Bureau of Public Debt, a branch of the Treasury Department.
He said the department would sell long bonds twice a year, while the 10-year note will be sold four times a year.
A Treasury Department spokesman declined to comment on the future of the long bond.

However, over the years the Treasury has eliminated other bond maturities, including the 20-year bond.
The price of 30-year bonds is rising as the supply falls, and the yield - which moves in the opposite direction to price - is decreasing.
The result: A 10-year Treasury now yields 6.5 percent, higher than the 6.2 percent on the 30-year. This is unusual at best, and some would say a market distortion.

"You could make the case that the 30-year is a misleading benchmark now," said Mr. McCarthy.

For example, the average maturity of bonds in the Lehman Aggregate Bond Index - a widely watched barometer - is about nine years.

Jack Kallis, portfolio manager of the State Street Government Income Fund, said he still monitors the long-bond yield, but tracks other, more important benchmarks as well.

Most bond mutual fund managers, he said, closely watch the London Interbank Offer Rate, known by the acronym Libor, which is set by several large international banks.

U.S. corporations, such as General Motors Corp. and IBM, often will issue fixed-rate bonds and later go into the international market and exchange these bonds with a new issue at a lower floating rate based on Libor.

This so-called swap market is larger than the U.S. Treasury market, he said."The benchmark for bond prices now is the swap market," said Mr. Kallis. "It used to be Treasuries, but not anymore."

Outside the U.S.
Ron Speaker, portfolio manager of the Janus Flexible Income Fund, said bonds with a 10-year maturity are already the benchmark outside the United States.

"The longest maturities on average around the world are 10-year bonds," said Mr. Speaker. "I don't think Japan or the United Kingdom issue much in the way of 30-year bonds."

Experts say the government's decreasing dependence on the long bond should continue as long as Washington follows through with plans to retire the entire U.S. debt by 2013.


However, those plans could quickly go awry if the economy slows and tax receipts dwindle, noted Deborah Boyer, portfolio manager of the T. Rowe Price Ginnie Mae Fund.
Forecasts for the federal surplus would decline and the government might have to start issuing new debt. It's still a little too soon, she cautioned, to write off the 30-year bond.
Like any corporation, she said, the government must spread borrowing "over the entire yield curve,'' meaning from two years to 30.
Won't vanish

"I don't think the 30-year will disappear," said Ms. Boyer. "I just don't see the benefit of completely getting rid of that part of the yield curve."

Mr. McCarthy of Stone McCarthy agreed that the "king isn't dead yet.''

"The problem is the king is still alive, and it's not entirely clear who the new king is going to be," he said. "What we have here is a succession crisis."


By Bill Deener / The Dallas Morning News



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