Observations On The US Government's Escalating Near-Term Funding Mismatch
When Lehman Brothers filed for bankruptcy, traditional money repositories, previously considered safe, were all promptly abandoned by investors unsure if they will have access to capital the next day. As a result, money markets, repos, even savings and deposit accounts were plundered in what has been the closest equivalent of a 21st century run on the bank. The only safe venue became US Treasury Bills, as almost overnight nearly half a trillion in very near maturities were invested in the US as the last perceived safe repository of investor capital.
The rush for near-term safety ended up creating a historic precedent of negative yields on near-term Bills: investors were willing to pay the government to hold their money for them.
So where do we stand a year later?
One would expect that as the financial situation improved, and credit was unlocked, that investors would abandon the safety of low-yielding Bills and pursue risk. Ironically, not only has this not happened, but in the 12 months since October 2008, over half a trillion more, $560 billion to be exact, has been parked in T-Bills. Looking at the entire treasury curve, over 40% of the $7 trillion in marketable treasury securities, matures within one year, a dramatic increase from the roughly 30% a year prior. The chart of the current T-Bill maturity schedule is presented below:
And here is how a Year-over-Year comparison from October 2008 to October 2009 and one year forward maturity data looks. As noted, the overall increase in near-term maturities has increased by a staggering $562 billion, or 25% from the $2.3 trillion in near-term (one year) maturities in 2008.
Practically every monthly period has seen an increase in T-Bill allocation by investors. This is a troubling trend.
But before we get into the details of what potential problems this may bring to the US, as the funding mismatch accelerates, this is how the entire curve of marketable securities looked like as of the most recent available data. As noted previously, over 40% of the entire $7 trillion in marketable securities matures essentially within one year.
Couple of observations here:
- The increased concentration in near-term UST maturities does not jive with repeated claims of a return to normal credit conditions. While last year's abnormal holdings of T-Bills was explainable as a run to quality from money markets in the wake of Lehman, the fact that this amount has expanded by more than half a trillion flies in the face of conventional wisdom that "everything is now back to normal."
- The bigger threat is one of asset-liability maturity mismatch. As the assets on the US balance sheet become increasingly long-dated, courtesy of QE, and locking in record low rates, US liabilities in turn have shortened their duration to a record level. Almost $3 trillion in US debt will have to be rolled by the end of 2010. If realistic inflation expectations are any indication, all hopes of getting comparable interest terms on these securities once refinancing time rolls around, will be promptly dashed (we are not saying inflation is inevitable, even with QE 2.0 around the corner). Yet for all who claim inflation is a good thing, the one security that will be hit the most and the fastest will be precisely the T-bill universe, once all the curve steepeners already in place unwind very, very quickly. The result would be a major spike in interest expense payments by the government. The chart below presents the historical annual interest expense on all USTs by year. 2009 will be the first year in which the interest expense alone will be over half a trillion dollars (Zero Hedge estimates).
The concern is that even as the US debt, which as of Friday was at $11,868,457,477,911.94, and looks like it will hit the $12.104 trillion limit within a few weeks, continues to skyrocket, the interest expense paid on holdings will continue creeping ever higher. Keep in mind, at September 30, the average interest rate on Bills was a historically low 0.347%, and Notes yielded a QE-facilitated 3.043%. With the Fed out, can China and US retail investors support this record low interest at a time when UST supply keeps coming and coming?
And that assumes that the roll of the T-Bills will continue to occur without a hitch, which at a time when the UST QE is over, may be a rather bold assumption.
Yet one thing is clear: so far the proverbial "money on the sidelines" has only found USTs and specifically low-yielding Bills to be attractive. Risky assets have been shunned. So at a time when the equity rally has already had a counterintuitive 60% run up, courtesy of a few HFT platforms, some hedge funds and the Goldman prop trading team, just what is it about the market fundamentals (or the economy) for that matter, that will force investors to leave the security of Bills and go into a massively overbought equity market? (And we say counterintuitive because never before have investors bought risky and safe assets with the same zeal at precisely the same time). The answer is unknown, although with a $9 trillion deficit in dire need of funding over the next decade, it is safe to say that investors in Treasurys will not have problems finding opportunities to park their money.