T-Bill Rates Surge as Auction Demand Falls Amid Budget Impasse

Rates on Treasury bills due in October soared and the U.S. attracted the least demand at weekly bill auctions since 2009 as Senate attempts to end the fiscal impasse were put on hold, increasing speculation of a default.

The $35 billion in three-month bills were sold at the lowest bid-to-cover ratio, which gauges demand by comparing the amount bid with the amount offered, since July 2009. The ratio for $30 billion six-month bills was the lowest since October

2009. Rates on bills due Oct. 24 jumped to the highest level since the securities were sold in April. Fitch Ratings placed the U.S. AAA on rating watch negative, citing the failure to raise the debt ceiling in a timely manner before the Treasury exhausts extraordinary measures.

“The tension and political risk is driving up bill yields and the nervousness has shown itself in the short end,” said Aaron Kohli, an interest-rate strategist at BNP Paribas SA in New York, one of 21 primary dealers that trade with the Fed. “Every headline is getting priced into the market. We are in for more volatility as you might need a stronger market reaction before congress gets their act together.”

The U.S. 10-year yield rose four basis points, or 0.04 percentage point, to 2.73 percent at 5 p.m. New York time, according to Bloomberg Bond Trader prices. The 2.5 percent note due in August 2023 slid 11/32, or $3.44 per $1,000 face value, to 98 1/32. The yield reached 2.74 percent, the highest level since Sept. 23.

The rate on bills due Oct. 24 rose 20 basis points to 0.46 percent after touching 0.51 percent, the highest since the bills were sold. The rate was negative as recently as Sept. 27.

Bill Auctions

The three-month bills sold today drew a bid-to-cover ratio of 3.13, below the 4.52 average over the past 10 auctions. The high rate of 0.13 percent was the highest since February 2011. The bid-to-cover ratio at the six-month bill auction was 3.52 versus an average of 5.07 at the previous 10 sales. It drew a rate of 0.15 percent, the highest since November 2012.

This was the second consecutive week bill auctions attracted poor demand amid budget wrangling in Washington.

“The bill auctions were very poor,” said Thomas Simons, a government-debt economist in New York at primary dealer Jefferies LLC. “Unless there is some type of agreement in Washington, the bill market will continue to trade choppily and auctions will not go well.”

Rating Concerns

“Although Fitch continues to believe that the debt ceiling will be raised soon, the political brinkmanship and reduced financing flexibility could increase the risk of a U.S. default,” Fitch analysts Ed Parker, Tony Stringer and Douglas Renwick wrote in a report published today. The company’s rating for the U.S. remains AAA.

Moody’s, which rates the U.S. a stable Aaa grade, reiterated yesterday that it expects the debt ceiling to be raised, averting a default. The company also expects “that the U.S. government will pay interest and principal on its debt even if the statutory debt limit isn’t raised.” Fitch and Standard & Poor’s, which haven’t commented on Treasury’s ability to prioritize payments, have also said they expect the U.S. to avoid default.

S&P’s AA+ grade for the U.S. already “incorporates the current level of discord” in Washington, John Piecuch, a spokesman for S&P, said yesterday in an e-mail that reiterated the firm’s stance. The company lowered the U.S. rating from AAA in August 2011 after the previous debt ceiling impasse citing “intractable” political disputes over fiscal policy.

Repo Rates

The overnight general collateral Treasury repurchase rate closed today at 0.27 percent after opening at 0.23 percent, according to ICAP Plc, the world’s largest inter-dealer broker. That’s up from 0.21 percent last Friday and more than double the

0.09 percent open at the start of last week.

U.S. government securities due in a decade and longer have fallen 10 percent this year, the biggest decline of 144 debt indexes worldwide tracked by Bloomberg and the European Federation of Financial Analysts Societies.

Senate talks aimed at ending the government shutdown and preventing a default are on hold and haven’t broken down, while the House considers its competing plan, said top leaders in the U.S. Senate.

Default Options

“We just need to wait and see what the House does,” said Adam Jentleson, a spokesman for Majority Leader Harry Reid. “We expect them to fail and then the Senate deal will re-emerge.” Michael Brumas, a spokesman for Minority Leader Mitch McConnell, said the Kentucky Republican hasn’t walked away from talks.

“The question is still when an agreement will be reached, and what will the damage to the economy and confidence have been,” said Jason Rogan, managing director of U.S. government trading at Guggenheim Securities LLC, a New York-based brokerage for institutional investors. “Any selloff we see will be tempered.”

A default may not disrupt markets as long as the U.S. alerted traders the night before a payment was due that it was probably going to default, giving the Federal Reserve’s Fedwire, an electronic service that transfers securities and payments, enough time to adjust its programs and allow the defaulted debt to be “transferable,” according to JPMorgan Chase & Co. That would allow them to continue to be used as collateral in repo markets.

‘Dangerous Flirtation’

“Treasury can, in principle, delay coupon or principal payment dates,” wrote Alex Roever, the head of U.S. interest-rate strategy at JPMorgan Chase & Co. in Chicago. “If Treasury announces its intention to postpone a payment date in advance, the day before the payment is due, the security will remain in Fedwire, and would therefore be transferable.”

Citigroup Inc. is bracing for a possible U.S. default by avoiding some short-term Treasury investments amid what Chief Executive Officer Michael Corbat called “a dangerous flirtation with the debt ceiling.”

Corbat made the remark during a conference call today to discuss third-quarter results at New York-based Citigroup. The bank doesn’t own Treasury securities that mature in October and holds few with terms ending before Nov. 16, Chief Financial Officer John Gerspach said.

Although rates on bills have risen, they are lower than historical levels. One-month rates have averaged 1.5 percent in the past 10 years. During that time they touched a high of 5.26 percent in November 2006 and dropped to a low of negative 0.09 percent in December 2008.

‘Trading Cheap’

Two years ago, one-month rates climbed to a 29-month high of 0.18 percent as the Aug. 2, 2011, deadline set by Treasury to avoid a default approached. They traded at negative 0.046 percent in December 2012 before a year-end trigger that forced automatic spending cuts and tax increases.

“Anything that had principal payments or coupon payments in October or November was trading cheap because people preferred other securities,” Francesco Garzarelli, co-head of macro and markets research at Goldman Sachs Group Inc., said in an interview with Francine Lacqua and Guy Johnson on Bloomberg Television’s “The Pulse” in London.

The Treasury Department will have no more than $30 billion on hand after Oct. 17. Depending upon daily tax receipts and incoming bills, the U.S. government could be forced to default on its obligations at any date thereafter -- to bondholders and millions of Social Security recipients.

The Bipartisan Policy Center, a Washington-based nonprofit research group, estimates that the Treasury will actually be unable to pay all the government’s bills on time at some point between Oct. 22 and Nov. 1. While the Treasury will probably be able to delay the true drop-dead date for a few days, it is unlikely to be able to do so beyond Nov. 1 because several large payments are due before then, the center says.

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