Two Tension Points To Watch In T-Bills

Tyler Durden's picture

Normally Treasury Bills are not something discussed around the dinner table or hotly debated on the business news channels. As UBS notes, the fact that the Tbill market has become the focus of attention is an ominous sign, and indicates that the stalemate over the debt ceiling could have profound effects. While TED-Spreads, and financial CDS were the key indicators in 2008, now we must watch money fund flows, and Tbill forwards. In a sense, the Tbill market is the proverbial canary in a coal mine for the US financial system. The canary is not yet back in good health.

Via UBS,

Tbill rates and volatility have surged

Normally Treasury Bills are not something discussed around the dinner table or hotly debated on the business news channels. The fact that the Tbill market has become the focus of attention is an ominous sign, and indicates that the stalemate over the debt ceiling could have profound effects.

Figure 1 drives home the point regarding the surging volatility of Tbill yields. October 24 is the first Tbill maturity that follows the Treasury Department’s self declared drop-dead date for the debt ceiling. Prior to the past few weeks, the yield typically moved in a 1-2bp daily range. In the last week, the trading range has widened enormously.

Money market and reserve manager sponsorship are key to the Tbill market

Tbill yields have surged because of political risk, not a potential shift in monetary policy. We are confident that Tbill holders have shunned the shortest maturity issues because they are concerned about timing and headline risk, not over worries about ultimately being paid. Tbill buyers are not paid nearly enough to take on issuer default risk. Consequently, some of them may choose to curtail their purchases or simply avoid the Tbill market until things calm. Figure 2 shows that money market funds focusing on US government securities have nearly $1 trillion under management. If this group retreats even marginally from the Tbill market then yields could jump, or remain high.

Foreign official institutions account for about $360 billion of Tbills (Figure 3). As we noted already, we expect this group of investors to be reasonably patient. They could back away from the Tbill market to some extent. However, we expect them to have much less influence on bill prices in the near term than the money funds.

The Tbill market has become a happier place on October 10. Yields have fallen considerably, and forwards beginning in late October and through November are much less negative than they were a day or two ago. Nonetheless, some forwards are still notably negative. This pattern tells us that bill investors are still quite nervous.

The bottom line: watch money fund flows, and Tbill forwards. In a sense, the Tbill market is the proverbial canary in a coal mine for the US financial system. The canary is not yet back in good health.