Debt-Ceiling Standoff Distorts Short-Term Treasury Market

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Investors demand higher returns on weak short-term treasuries, but yields fall on others

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Similar bond-market distortions had flared up in the past when governments exceeded their legally-imposed borrowing limits. Blake Gwynn, head of US interest rate strategy at RBC Capital Markets, said traders are not really afraid that the government will not pay back the money it owes. But a cash crunch for a few days before lawmakers struck a deal would spell headaches for asset managers and custodial banks, which use computer systems not designed to deal with bonds that continue to mature.

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In 2013, the Treasury Market Practice Group—a group of market professionals sponsored by the New York Federal Reserve—issued guidelines that it “may reduce, on margin, some of the negative consequences of delayed payments on Treasury loans.” Nevertheless, it concluded that “the consequences of such delays would nonetheless be dire” as some market participants may not be able to implement the practices, while others will have to “rely on substantial manual intervention – a recourse that may lead to additional creates operational risk.”

Typically, investors seek higher yields for Treasuries with longer maturities to offset the risk of accelerating inflation or the Federal Reserve raising interest rates. This also applies to the shortest term loans – securities known as bills with maturities of one year or less.

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In recent weeks, however, bills that mature from mid-October to mid-November have offered higher yields than those maturing in later months. This is because of the risk that the government could reach its borrowing limit around that time period and not have the money to pay its creditors immediately.

On Tuesday, yields on a handful of bills got an extra boost when Treasury Secretary Janet Yellen told Congress the government could reach its borrowing limits by October 18, after which it would be uncertain whether it would be able to meet its payment obligations. Will happen. Ms Yellen had previously only said that the government could exhaust its capabilities to extend its lending authority in October, making it difficult for traders to know which bills to avoid.

According to TradeWeb, a bill due on October 19, at the end of the US trading session, offered a bid return of 0.074%, up from 0.048% prior to Ms. Yellen’s statement. The bill payable on 2nd December was yielding only 0.025%.

The current distortions in the $4 trillion bill market are still mild compared to some in the past. Yields on some bills rose sharply in 2011, when former President Barack Obama and House Republican leaders reached an agreement to raise the ceiling two days before the Treasury estimated that it would have reached its borrowing limit.

Investors are generally hesitant to dump bills unless the Treasury provides a narrow time frame when it will run out of cash. This year has been difficult as some sort of pandemic relief is being distributed at unexpected times. Tax receipts are also difficult to forecast as waves of Covid-19 cases affect the pace of the economic rebound, making it doubly difficult to forecast the government’s cash holdings.

Meanwhile, debt-limit battles are generally dragging bill yields more than they should be moving upwards.

This is because of pressure on the Treasury to avert the threat of a financial crisis for as long as possible, in part by slowing its borrowing and pushing the day off when total US debt collides against its limit.

Reluctant to reduce or delay auctions of long-term debt, the Treasury has instead cut issuance of bills, creating a shortage in that one corner of the market.

The volume of outstanding bills, in fact, was already declining for most of the year due to various reasons, but that trend has accelerated. This week, the Treasury plans to issue bills worth $149 billion, while paying $276 billion at maturity — a net payment of $127 billion. This comes after reducing the amount of outstanding bills by $116 billion last week and $68 billion a week before that.

A smaller influx of new loans, along with heavy down payment of bills, has given hiring investors more cash and less room to keep that money, causing them to pay higher-than-usual premiums for bills. .

Typically, investors will not buy bills that offer a lower yield than those paid by the Fed through its overnight reverse repo facility. However, on Tuesday, the bid yield on the three-month bill was 0.041%, according to Tradeweb – down from 0.053% at the end of August and comfortably below the 0.05% rate set by the Fed.

“All else being equal, you should be indifferent to keeping your cash at the Fed for five basis points, versus five basis points,” said Thomas Simmons, senior vice president and money-market economist in the fixed income group at Jefferies LLC. . “If there’s a reason investors need to buy bills and they’re paying through that five basis point level, that’s a sign that supply is very, very tight — bills are scarce.”

Sam Goldfarb [email protected] . Feather


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