US Treasury to boost 10-year note sales as fiscal deficit swells

By David Lawder

WASHINGTON, July 25 (Reuters) - Faced with a swelling federal budget deficit as a slowing economy saps tax revenues, the U.S. Treasury is expected to boost the frequency of 10-year note sales and offer more 30-year bonds next month.

Analysts estimate the Treasury will announce plans to sell $15 billion to $16 billion in 10-year notes and $9 billion to $10 billion in long bonds at its refunding announcment on Wednesday.

"There's a realization that these higher deficits are going to be with us for a while because the outlook for growth in the second half and into next year has deteriorated," said Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey. "It's an appropriate time for the Treasury to be locking in some longer-term borrowing."

Analysts widely anticipate that the 10-year note auctions will move from quarterly to monthly, with new issues and reopenings every other month. It sold $15 billion 10-year-notes and $6.0 billion in 30-year bonds in the last quarter

The Treasury signaled at its last refunding at the end of April that it may bring the 3-year note out of retirement, but several analysts said more issuance in longer maturities were needed to balance supplies with with market demand.

The Treasury held a record $31 billion auction of 2-year notes two year notes on Wednesday and has sharply increased sizes of bill offerings, including $52 billion of 1-year bills this quarter alone after reintroducing them in May.

"The biggest problem with bringing back the three-year is that front-end supply have already been increased significantly" Barclays Capital analysts wrote in a research report on Friday. There are "clear signs that investors may balk at more supply there if financial market volatility eases."

Analysts also said the Treasury also could bring back seven-year notes as another option to meet longer-term demand. Although 30-year bond sizes will likely increase, the maturity is "relatively expensive" for the Treasury, Crandall said.

On Friday the long bond US30YT=RR was yielding 4.69 percent, compared with 4.10 percent for 10 year notes and 3.44 percent for 5-year notes.

FALLING REVENUES, HIGH SPENDING

Driving the need to expand borrowing is a deteriorating budget situation, driven by falling corporate income taxes and continued high spending for the wars in Iraq and Afghanistan, as well as an economic stimulus program to support the economy.

A housing rescue package due to be approved by the Senate on Saturday adds an additional $4 billion in grants to communities to repair homes, and if housing giants Fannie Mae (FNM.N) and Freddie Mac (FRE.N) need government bailouts, the price could be around $25 billion, according to congressional researchers.

Since late April, the government has sent out $91.8 billion worth of tax rebate checks to 112.4 million American families and individuals, which has helped to prop up consumer spending. The bulk of the checks have gone out, but small batches will continue to be sent as households file late tax returns.

The White House is expected to release its latest budget deficit estimate on Monday for the 2008 fiscal year ended September 30, and analysts expect it to climb into record territory from the $410 billion estimated in February.

This compares with $163 billion in fiscal 2007 and a record $413 billion in 2004.

Through the first nine months of fiscal 2008, the government's deficit was $268.7 billion, compared with a $121 billion deficit for the same period a year earlier.

Merrill Lynch analysts Drew Matus and David Rosenberg estimate that the fiscal 2009 budget deficit will top $500 billion, which presents a "daunting" task for the Treasury of arranging $1 trillion in financing next year. It will have to turn to the 3-year note to close the funding gap.

"This security would appear to give the Treasury the most flexibility to meet unexpected changes in funding needs and its reintroduction seems likely to be a topic of dicussion at this refunding announcment," they wrote. (Reporting by David Lawder)