NEXT UP-US Treasury debt soars, 7-year note may return

(Updates with U.S. Treasury borrowing estimates)

By David Lawder

WASHINGTON, Feb 2 (Reuters) - The U.S. Treasury, facing unprecedented borrowing needs, is expected to bring the 7-year note out of retirement and may dump its 5-year inflation-indexed notes to make way for better-selling maturities.

As the government battles the worst financial crisis since the Great Depression, the Treasury's borrowing needs this year are expected to soar to an unprecedented $2 trillion in fiscal 2009 from about $788 billion in fiscal 2008, more than four times the previous year. The fiscal year began in October.

The Treasury is expected to announce a refunding package of $69 billion to $75 billion on Wednesday, including all new money 3-year notes as well as refunded 10-year notes and 30-year bonds.

On Monday the Treasury said it expects to issue $493 billion of net marketable debt in the January-March quarter, up $125 billion from the previous estimate, as recession eats into tax revenues and financial stability programs need continued support.

The estimate compares with a record $569 billion in October-December quarter, but it does not include any financing for the President Barack Obama's proposed stimulus plan, which has grown to nearly $900 billion.

The Treasury resurrected the 3-year note in November and analysts say its debt arsenal will have to grow further to pay for the stimulus and potentially more bank and housing rescue programs.

"The 7-year note seems the most likely to be brought back, but you can't rule anything out given the speed at which borrowing needs are increasing," said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey. "We also could very easily see a new set of options laid out for consideration next quarter.

The Treasury, which last sold 7-year notes in April 1993, could start issuing this maturity on a quarterly basis at $25 billion to $30 billion a clip, Barclays said.

"The return of seven-year notes would give "added flexibility in case borrowing needs turn out even higher than we are forecasting of now," said Barclays analysts, who are also looking for an issuance increase in 5-year notes.

Since the Treasury likes to telegraph changes to its auction calendar well ahead of time to avoid market disruptions, auctions for any new maturity or changes to the calendar would likely not occur until the April refunding at the earliest.

BORROWING STRATEGY

The Congressional Budget Office has estimated that the U.S. budget deficit will more than double to $1.19 trillion in fiscal 2009, before the stimulus spending is counted. The U.S. Treasury's primary bond dealers, in a survey released on Monday, estimated the budget gap at $1.63 trillion, with estimates ranging as high as $1.72 trillion.

To fund these, Treasury auction sizes across all maturities are expected to increase. And to ensure that auctions achieve maximum demand, the Treasury may clear away underperforming maturities, such as the 5-year TIPS, said Crandall.

"The 5-year TIPS have been the least effective of the various TIPS and they may not want to reserve a spot on their auction calendar for a maturity that can only raise $6 billion to $8 billion."