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.

6 comments

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Made 200 million or 200 billion?

Posted by MervynP | Report as abusive

Amazingly, that $200 million–which the FT is rather cavalier about–does not appear (from what I can tell) in all of the accountings of How Well TARP Worked.

Posted by klhoughton | Report as abusive

Haven’t investors been exposed off and on to negative yields on TIPS since the crisis of ’08?

Posted by GRRR | Report as abusive

Huge short term treasury interest probably means investors are terrified of the long end of the yield curve. That doesn’t seem to be a vote of confidence in US debt at all.

If you believe interest rates are on the way up, stocks and long bonds could both get hit and then T-Bills are the best of a bad bunch.

Posted by DanHess | Report as abusive

Felix, explain to me how the Treasury could fail to pay interest in its own currency.

It’s unreal that people think our government is revenue constrained.

Even Paul Krugman has been willing to talk about Modern Monetary Theory.

Felix, why do you tap dance around this issue? I’d like to think you aren’t enthrall to the deficit peacocks like Peter Peterson.

Posted by petertemplar | Report as abusive

Agreed with DanHess, rising interest rates push investors to the short end. I’ve been making that conscious decision myself, not particularly motivated by fear of default (I hold some long-duration TIPS) but by fear of having inflation eat my principal.

Posted by TFF | Report as abusive