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Treasury Considers Eliminating 3-Year Note

The U.S. Treasury said that strong tax receipts and an improving fiscal outlook may prompt it to eliminate or change the auction frequency of its 3-year note.

The Treasury, announcing a $38 billion refunding of 3- and 10-year notes and 30-year bonds slated for next week, said it will reveal a decision regarding the 3-year note in its next refunding statement on May 2.

Regardless of that decision, the Treasury confirmed it will auction a 3-year note in the May refunding.

Driving the Treasury's deliberations are burgeoning tax receipts driven by rising wages, strong corporate profits and stock market gains.

The Congressional Budget Office last week estimated the U.S. budget deficit would narrow to $172 billion in the fiscal year ended Sept. 30 from $248 billion the prior fiscal year.

On Monday, Treasury said it would need to cut its net borrowing to $141 billion in the current quarter -- $35 billion below an estimate made in October.

Still, Treasury Assistant Secretary for Financial Markets Anthony Ryan emphasized flexibility in how to cut debt issuance.

"Treasury may need to reduce auction sizes further or institute changes in the frequency or composition of the current auction cycle," he said in a statement.

Ryan told a news conference that Treasury saw the most market flexibility to reduce debt at the shorter end of the yield curve and the lightly benchmarked 3-year note "seemed the optimal candidate" to consider for elimination.

The Treasury halted sales of the 3-year note in 1998 during the last major boom in tax receipts and resumed them in 2003. Annual Treasury debt issuance has retreated since peaking in 2004 at $4.69 trillion.

Committed to Long Bond

Ryan also said, however, the Treasury remains "very committed" to the 30-year bond, which was brought out of nearly four years of retirement in 2006.

Treasury plans quarterly long-bond auctions this year, with total issuance expected to exceed last year's $24 billion.

But it will only offer $9 billion in 30-year bonds on Feb. 8, "a pretty bare-bones auction," said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey.

Ryan said the Treasury would be in a better position to determine its debt needs after the spring tax filing season.

Treasury currently expects to pay down $130 billion in net debt during the April-June quarter. The refunding announced today will raise $2.9 billion in new cash.

Some members of the Treasury Borrowing Advisory Committee, made up of 22 primary bond dealers advocated reducing issuance of bills and other shorter-term securities from current levels as well as the 5-year Treasury Inflation Protected Securities (TIPS), saying demand for these is lower than 10- and 20-year notes.

"Members generally thought that if Treasury needed to eliminate an issue, it would be appropriate to eliminate the 5-year TIPS," minutes of the meeting said.

Crandall said that Treasury's decision not to mention possible changes for 5-year TIPS suggests that it may want more time to ensure that tax receipt gains are sustainable and the
federal budget outlook continues to improve.

"Treasury is keeping its options open," he added.

The Treasury also said it would soon begin testing its new auction system, designed to update existing technology, automate manual processes, and continue to maintain the speed and reliability of the auction process. Testing will continue until summer 2007, at which time Treasury will ask dealers and investors to participate in mock auctions on the system.