Bloomberg News

U.S. Strips Formation Falls for Sixth Month Amid Twist Program

February 07, 2012

Feb. 6 (Bloomberg) -- The outstanding amount of zero-coupon U.S. Treasury notes and bonds fell for a sixth straight month in January, the longest stretch of declines since 2009, as the Federal Reserve’s Operation Twist program soaked up securities.

Zero-coupon debt, or strips, short for separate trading of registered interest and principal securities, is created by Wall Street firms that split bonds into their face amount and individual coupon payments. The amount of strips fell by $290.6 million, or 0.15 percent, to $195.2 billion last month, Treasury Department data show. Strips reached a more-than 10-year high of $207.5 billion in July.

The central bank said in September it would sell $400 billion of short-term debt in its holdings and buy an equal amount of longer-maturity Treasuries. Traders call the program Operation Twist after a similar effort in 1961 to contain borrowing costs for companies and consumers. Policy makers also have held they key interest rate at zero to 0.25 percent since 2008 and pledged last month to keep it low into 2014.

“The Fed buying a lot of longer-dated bonds and keeping rates so low is causing the trend of declining STRIPS issuance,” said Charles Parkhurst, a strips trader and managing director on the government bond trading desk in New York at Barclays Plc, one of the central bank’s 21 primary dealers.

The Fed seeks out the cheapest securities for purchase, which also happen to be the securities that most often get stripped, Parkhurst said.

‘Less Demand’

“The bond market has rallied so much, and we are in such a low-interest-rate environment, that there is just less demand for the formation of the products,” he said. “And if rates stay low, the trend will continue.”

Thirty-year strips have lost 7.2 percent this year after beating the rest of the $7.9 trillion market for Treasuries last year, a Bank of America Merrill Lynch index shows. They returned 67 percent in 2011, almost double the 36 percent gain for 30- year bonds and more than six times the 9.8 percent gain in the broader Treasury, the indexes show.

“Because of the Fed’s purchases on the long end, which are significant, especially relevant to supply, there is more demand for whole bonds than there are for STRIPS,” said Thomas Simons, a government-debt economist in New York at the primary dealer Jefferies Group Inc. “Combine that with a low interest-rate environment, and zero coupon bonds don’t offer as much value anymore.”

Zero-coupon bonds are the most efficient way for money managers to increase duration, a measure of portfolio risk. The duration of a zero-coupon bond is the same as its maturity, while coupon-bearing bonds have shorter durations.

An estimated $8.5 trillion of Treasury securities were eligible for stripping last month, while $8.3 trillion were held in unstripped form. In addition, $21.1 billion of formerly stripped Treasury securities were reconstituted, the Treasury data show.

--Editors: Greg Storey, Dave Liedtka

To contact the reporter on this story: Cordell Eddings in New York at ceddings@bloomberg.net

To contact the editor responsible for this story: Dave Liedtka at dliedtka@bloomberg.net


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