The unexpected T-bill rally

By Felix Salmon
April 5, 2011
just look what's happened to the market in short-term Treasury bonds!

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With time rapidly running out before the debt ceiling is reached, and doom-mongering rampant about the disastrous possible consequences of the US Treasury being unable to repay its debts, just look what’s happened to the market in short-term Treasury bills!

The lack of supply was so severe on Monday, and some investors so desperate for Treasurys, that they accepted negative yields. That is something that has rarely been seen since the financial crisis.

In other words, the market simply isn’t worried about short-term US debt at all. Instead, Treasuries are rallying on what the FT describes as “the collapse of a profitable arbitrage opportunity that financial groups have used to rebuild their balance sheets after the financial crisis.”

Since late 2008 banks have made about $200 million by borrowing very cheaply in the repo markets and investing the proceeds at the Fed. But now the FDIC is levying its insurance fee on repo liabilities as well as on deposits — and that fee means the free-money machine has printed its last greenback for the banks.

With the banks no longer borrowing money in the repo markets, the people on the other side of the trade — lenders to the repo market, which are often money-market funds — have found themselves with nowhere to safely park their short-term cash. Hence the rally in Treasury bonds: it’s a product of increased demand (from money-market funds) combined with decreased supply (as the Treasury tries to borrow more at the long end and less at the short end of the curve, and as QE2 mops up much of what is being issued).

All the same, I can promise you that if short-term Treasury yields were going up rather than down, the financial press would be talking incessantly about the debt ceiling, even if the reasons were entirely technical, as they are here. So this is a good reminder that moves in the Treasury market are generally not a referendum on government policy or Congressional grandstanding. Even when they do fit the daily news narrative.

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