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What is the effect on the strips market of the Treasury buybacks? I own 2025 strips. Can they be called before they mature? -- Joe Newbold

Joe,

The effect of the

Treasury Department's

debt buyback program on your strips is either nothing at all or a thing of great beauty, depending on how you look at it.

It has no effect at all in the sense that your strips -- Treasury zero-coupon bonds -- are not among the securities that the buyback program is targeting. In short, the government doesn't want your bonds.

But the effect has been quite wonderful because the announcement of the buyback program drove the price of all long-maturity Treasuries way up, regardless of whether they were likely to be buyback targets or not. Your strips are long-maturity Treasuries, and they are among the best-performing Treasury issues so far this year. Through the end of February, they were up more than 12%.

Let's review this whole buyback issue for those who haven't been paying close attention.

Surplus Side-Effect

The federal government is running a surplus, and it expects to continue to do so unless and until there is a radical change in the growth rates for its revenues, expenditures or both.

The Treasury Department issues bonds, notes and bills in order to finance the federal government's deficits. With no deficits, there's no need to issue bonds, notes and bills.

Here's where the buybacks come in. If the Treasury Department were simply to quit issuing new securities, it would wipe out much of the Treasury market, which exists to trade the most newly issued Treasuries. That would have widespread implications, since Treasury yields are global benchmarks.

Consequently, the department has decided to continue issuing new securities and to spend surplus funds to buy back from investors old securities, which are seldom traded anyway.

The buyback program has been under consideration by the Treasury Department and the bond industry for years, but it was

launched only on Jan. 13. Then on Feb. 2, the department

confirmed what everyone had expected about the buyback program -- that it would target long-maturity issues, which are the government's most expensive debt because they carry the highest interest rates.

The department said it would attempt to buy back up to $30 billion of long-maturity Treasuries this year, about $1 billion at a time. So far, it has done two $1 billion buybacks, the first on

TST Recommends

March 9 and the second on

Thursday.

30-Year Bonds Targeted

Here's how the buybacks work: The Treasury announces which issues it wants to buy back. For example, in the first buyback, it asked for 30-year bonds that had been issued between 1985 and 1990. In the second, it asked for 30-year bonds that had been issued between 1988 and 1991.

Then, at a specified time, it takes offers on those securities from primary dealers, which are the securities firms that are the main buyers and sellers of Treasury securities. In other words, the dealers specify the prices at which they are willing to sell the specified bonds back to the government. Dealers have to offer a quantity of at least $100,000, but no one is required to offer anything. If you own any of the bonds targeted by the buyback program, you can keep them. In fact, unless you own at least $100,000 of an issue, you can't offer them to the government. Even if you own at least $100,000 on an issue, you'll have to get a dealer to offer them on your behalf. And there's no guarantee that your offer will be accepted. The Treasury Department looks at all the offers, and accepts only the lowest ones.

The Skinny on Strips

Not only are your strips not on the list of securities that so far have been targeted by the buybacks, but they are not going to be, at least not in their current form. As a previous

Fixed-Income Forum explains in greater detail, strips are Treasury zero-coupon bonds.

A zero-coupon bond is a type of bond that does not make interest payments. Instead, it is issued at a deep discount to face value, and then, like other bonds, matures at face value. The yield is a function of the difference between the purchase price, the face value and the time till maturity.

The Treasury Department doesn't issue strips. Strips are created by bond dealers, who take regular, interest-paying Treasury securities, break them up into their component cash flows, and sell each one separately. Dealers call the process stripping, but the acronym stands for separate trading of registered interest and principal securities.

A bond that has been turned into strips can subsequently be reconstituted if a dealer can get its hands on all the component parts. So it's possible that the Treasury might someday seek to buy back the bond that your strip came from. But in order for your strip to be purchased by the government, you'd first have to sell it to a dealer interested in reconstituting that bond from its component strips. Again, no one can force you to do that. And since strips are noncallable, you are at no risk of losing them before they mature.

Having said all that, your strips have been fabulous performers this year, in large measure because of the buyback program. Long-maturity Treasuries like yours have outperformed all other Treasuries by a wide margin. This is the force that has inverted the Treasury yield curve, sending long-maturity yields below short-maturity yields as the prices of long-maturity Treasuries rise disproportionately.

Through the end of February, a 25-year Treasury strips index had returned 12.19% for the year, according to

Bianco Research

. By contrast, the average return for the period of all the Treasury benchmarks was just 1.26%.

Individual issues may have performed even better. A Treasury principal strip (see the column cited above for the difference between principal and interest strips) due in August 2025 was quoted Thursday at a dollar price of 21.85 to yield 6.09%. That's up from 18.00 on Jan. 18, when the yield was at 6.82%. That's a 21.4% gain. The quotes are for a round lot of at least $1 million. A smaller lot won't fetch as high a price. Still, you're sitting on an awfully tidy profit.

Send your questions and comments to

fixed-incomeforum@thestreet.com, and please include your full name. Fixed-Income Forum appears each Friday.

TSC Fixed-Income Forum aims to provide general bond information. Under no circumstances does the information in this column represent a recommendation to buy or sell bonds, funds or other securities.