The $900 Billion Influx That’s Wreaking Havoc in U.S. Bills

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Five dollar bills at the Bureau of Engraving and Printing in Washington, D.C.
Five dollar bills at the Bureau of Engraving and Printing in Washington, D.C.
Photographer: Andrew Harrer/Bloomberg

For all the anxiety over the global selloff in bonds, the big worry in money markets is the havoc being created by a dearth of U.S. Treasury bills.

The magnitude of the problem was on display last week, when not even the Treasury Department’s surprise announcement to boost sales could do much to lift bill rates. Over the past two weeks, some of those rates have turned negative, reaching levels last seen during the financial crisis.

With supply at multi-decade lows, investors are signaling alarm as regulations intended to shore up banks and prevent a run on money-market funds exacerbate the bill shortfall. JPMorgan Chase & Co. expects an extra $900 billion of demand for government securities during the next 18 months, putting pressure on a sizable chunk of the $1.4 trillion bill market.

“You have all this money that wants to be in liquid, safe assets that is overwhelming the supply,” said Alex Roever, the Chicago-based head of U.S. interest-rate strategy at JPMorgan.

The consequences extend well beyond the fixed-income market as depressed rates in the $2.5 trillion money-market fund industry stand to deprive savers of income long after the Federal Reserve starts raising interest rates.

The mismatch between supply and demand has been so acute that four-week bill rates fell to minus 0.0304 percent on April 29, the lowest on a closing basis since December 2008. Yields on three-month bills also turned negative. The Treasury responded by saying at its quarterly refunding announcement on May 6 it would increase issuance to meet growing demand.

Clear Signal

It didn’t provide any details on how soon it would start selling more bills or much it would auction.

“It is clear that that demand is large and is growing,” Seth Carpenter, acting assistant secretary for financial markets, said in the press conference in Washington. “We are improving market functioning in the Treasury bill market by increasing the supply.”

While some short-term rates increased after the Treasury’s announcement, it didn’t last long. By Friday, the rate on the four-week bill had fallen back to zero. It was 0.0051 percent as of 12:15 p.m. in New York.

Because it’s unlikely the Treasury will start selling immediately, supply will probably keep falling, according to Jefferies Group LLC. The firm estimates the amount of bills, which come due in a year or less, may drop by about $30 billion through June 25.

Maturity Shift

Bills outstanding have decreased almost 30 percent since the end of the recession after stronger U.S. growth boosted tax receipts and narrowed the budget deficit to a seven-year low.

“It’s not like the Treasury is going to come all of a sudden to market with a trillion dollars in new bills to help everyone out,” Thomas Simons, a government-debt economist at Jefferies, one of the 22 primary dealers that are obligated to bid at U.S. Treasury auctions, said from New York.

At the same time, the government has shifted its borrowing to longer-term debt, locking in historically low rates before the deficit is expected to start growing again in 2016.

The average maturity of U.S. debt outstanding has lengthened to 69 months, the longest since 2001, as the amount of bills has decreased to about 11 percent of the Treasuries.

The repercussions are likely to hit the money-market industry just as tougher regulations prompt providers to focus on funds that invest only in government debt.

Bill Squeeze

BlackRock Inc., the world’s largest asset manager, said in April it will add government-only funds to comply with the new rules, two months after Fidelity Investments said its $110 billion Fidelity Cash Reserves Fund will stop buying short-term corporate debt and transfer assets to government securities.

Andrew Hollenhorst, a fixed-income strategist at Citigroup Inc., says the regulatory change may move “hundreds of billions” of dollars into Treasury bills.

“You are not really meeting the additional supply that needs to be there,” he said from New York.

Higher capital requirements, which have made deposits more costly for banks to hold, are contributing to the imbalance. Lenders have added fees to dissuade some depositors from parking cash, meaning the money is likely to wind up in bills.

The bill squeeze is occurring as investors worldwide fled longer-term government bonds in the past month. The tumble was triggered in part by bond titans Jeff Gundlach and Bill Gross, who questioned whether the rally was overheated.

Fed Credibility

Even Fed Chair Janet Yellen warned of a “sharp jump” in yields once the central bank increases rates and suggested long-term debt was overpriced.

Yields on the 10-year note was at 2.23 percent Monday, from 1.82 percent in early April. Those on German bunds soared to 0.61 percent after falling below 0.1 percent last month.

For Jefferies’ Simons, the overwhelming demand for bills even has the potential to undermine the Fed’s ability to control monetary policy by pinning short-term market rates well below the central bank’s target rate.

“The biggest problem is that this would not be good for general Fed credibility,” he said. “If the Fed can’t prove they have control over front-end rates, it’s unlikely that they will be effective in any of their monetary policy goals.”

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