More Cracks in Debt Markets as U.S. Four-Week Bill Rates Plunge

It’s not even the end of the quarter, when demand by investors to park cash in the safest of places is the most extreme, and Treasury four-week bill rates have already dropped to levels rarely seen since the financial crisis.

A negative discount rate of 0.0406 percent may just be the latest example that bond markets haven’t returned to normal more than seven years after the global financial crisis.

Regulations enacted since to make banks sound and prevent an implosion of the money market mutual fund industry have left less short-term debt instruments, such as repurchase agreements, available, leading to surging demand for government securities at month- and quarter-end. The shift has come while the U.S. Treasury reduces the amount of bills sold in favor of longer-maturity debt as part of plan to lock in lower borrowing costs with interest rates lingering close to historic lows.

“The bigger theme is that in a balance-sheet encumbered world, which it is creating a structural scarcity issue for short-term Treasury bills, these types of situations for month-end and quarter-end will be the norm,” said Kenneth Silliman, head of U.S. short-term rates trading in New York at Toronto-Dominion Bank’s TD Securities unit.

The rate on the four-week bill was the lowest since July 2013. While bill yields have sporadically dipped below zero since they first breached that level in December 2008, when investors sought the relative safety of short-term U.S. government securities after the collapse of Lehman Brothers Holdings Inc., a move to such a negative extreme has been rare.

Capital Standards

The amount of bills outstanding had dropped 29 percent to $1.48 trillion, from $2.07 trillion in August 2009.

Demand for government debt is set to rise by some estimates as much as $500 billion as money-market funds cut back on offering products that must show daily asset value changes and focus more on ones that buy only government debt.

Demand for the safest short-term investments has increased in recent years as investors and institutions respond to more stringent liquidity and capital standards on banks imposed by regulators. Some measures have made participation by U.S. banks in the repurchase agreement market more costly and less attractive, triggering them to dim activity.

The amount of securities financed through a part of the market known as tri-party repo is down 15 percent to $1.66 trillion since December 2012, and more than 41 percent from its 2008 high.

General Collateral

Given the dearth of places to park cash, money-market mutual funds have ramped up usage of the Federal Reserve’s reverse-repo facility at month- and quarter-end. The Fed’s has been testing the program as tool for when it eventually removes its unprecedented monetary accommodation.

Earlier this month, given extreme volatility in repo rates in 2015, the Treasury department queried its primary dealers whether making adjustments at bill auctions will help to ease the volatility in the short-term market for borrowing and lending debt.

Repo rates surged on March 31 to the highest level since 2012. The Depository Trust & Clearing Corp.’s general collateral finance repo index reached 0.45 percent, the highest since October 2012, at the end of March. That was up from as low this year as 0.059 percent on Feb. 23.

“This situation could be even worse later in the year when the Treasury needs to cut bill supply for the debt ceiling, at a time when more funds could be flowing into government-only money market funds due to money-market reform,” added Silliman. “We could see a perfect storm environment developing in the marketplace that the Treasury will not be able to address because they will be hampered by debt-ceiling limitations.”

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