Congress raised the debt ceiling early this week, which opened the door for the Treasury to increase the issuance of Treasury bills through the end of the calendar year, anticipating large demand from Prime funds converting to Government funds. The minutes from the Nov. 3 meeting of the "Treasury Borrowing Advisory Committee of the Securities Industry and Financial Markets Association," say, "Deputy Assistant Secretary Clark began by noting that Treasury has started to return Treasury's cash balance to a level generally sufficient to cover one week of outflows subject to a minimum balance of roughly $150 billion. DAS Clark explained that increasing the size of bill auctions would help to accomplish this goal and that Treasury forecasts a $147 billion net increase in bill issuance during the first quarter of FY 2016. He noted that Treasury bill auctions would likely remain at elevated levels through the end of the calendar year." We review the Treasury's plans for bill issuance and the start of the migration of Prime funds to Government money funds below.
The minutes continue, "Additionally, DAS Clark reiterated Treasury's commitment to increasing the supply of bills outstanding over the coming fiscal year. He noted that Treasury would only need to increase net issuance by $68 billion in FY2016 if coupon auction sizes remained constant and if the Federal Reserve chose to fully reinvest its maturing Treasury securities. Thus, DAS Clark highlighted that adjustments to Treasury's coupon auction sizes may prove necessary to support a meaningful increase in the supply of bills over that same timeframe. DAS Clark noted that significant reductions to bill auction sizes over the last fiscal quarter, in response to the debt limit constraints, had resulted in a corresponding rise in bid-to-cover (BTC) ratios for those securities. Specifically, he observed that BTC ratios for the four-week bill auction reached a historical high."
The TBAC minutes go on, "Next, Acting Assistant Secretary Seth Carpenter delivered a presentation to the Committee on the potential benefits and drawbacks of issuing a two-month Treasury bill maturity.... Carpenter noted that market participants generally agree that demand for Treasury bills will continue to increase as some large prime money market mutual funds convert to government-only money market mutual funds (MMFs). Additionally, changes to the way that some large banks classify certain types of deposits may also lead to increased demand for short-term high quality government assets."
They continue, "He also noted that many market participants view bills as a close substitute to repo; thus, declines in dealer repo capacity may also increase the demand for bills. Carpenter explained that government-only MMF data from January 2012 to July 2015, excluding FRNs, indicate that 40 percent of these funds' Treasury holdings mature within one month, while 76 percent of their Treasury holdings mature within three months. Carpenter also noted that these same data indicate that the WAM of these funds' Treasury holdings has oscillated between 60 and 80 days. Accordingly, these data indicate that MMFs have a need for short-dated Treasury issuance."
The minutes add, "Carpenter highlighted Treasury's analysis that showed the potential benefits of a two-month bill maturity. Specifically, he noted that, by as early as 2017, the average one- and three-month auction sizes could exceed the maximum auction sizes recommended in the most recent primary dealer auction survey. Carpenter showed how the addition of a two-month bill would help Treasury increase bill issuance without increasing auction sizes beyond the primary dealer recommended maximums. The Committee engaged in a detailed discussion regarding the potential addition of another bill maturity and most members agreed that there would be benefits given the demand for bills, particularly from the MMF community."
They continue, "While some members agreed that a two-month bill would be a good addition to Treasury's existing suite of maturities, some members noted that a shorter-dated maturity, such as a two-week bill, may be better suited for MMFs that need short-term assets as a substitute for declining repo capacity by the dealer community. One member cited the potential for a cleared repo facility as one way that market participants' demand for repo could be met and that the likelihood of such a facility should be considered when determining the maturity of a new Treasury bill. The Committee concluded that Treasury staff should engage with market participants about a new bill maturity and prepare a follow-up presentation for the Committee at a future meeting."
In a November 3, "Report to the Secretary of the Treasury," TBAC Chairman Dana Emery writes, "Treasury, due to the debt ceiling, is currently operating below the recommended $150 billion minimum daily cash balance that was established in May 2015. Treasury plans to increase Tbill issuance significantly, by increasing the size of the 4-week, 3-month and 6-month auctions and through cash management bill issuance. Based on the current auction schedule, Treasury is projected to increase new bill issuance by $186 billion by the end of December 2015 and to increase its forecasted end-of-quarter cash balance to $344 billion. Given the high demand for Tbills due to money market reform and regulatory changes, the Committee believes increased Tbill issuance will both enhance market functioning and help the Treasury achieve low cost funding."
Emery adds, "The Committee discussed the benefits of increased Tbill issuance to enhance short-term market functioning, recommending an increase above the projected shortfall. Therefore, the Committee recommended that the Treasury consider a moderate reduction in coupon issuance in coming quarters, assuming revenues and outlays remain as projected. As a follow-up to the Committee's May request and in light of the expected shift of assets from prime to Treasury money market funds, Treasury provided an initial assessment of potential introduction of 2- month bills to distribute Tbill issuance across more maturities and to address increased projected demand for Tbills due to market structure changes and money market reform.... The Committee agreed that the 2-month Tbill was worth exploring further, particularly with money market fund managers. One member noted that money market demand has displayed seasonal patterns and that demand may be more centered in maturities of one month and shorter."
The supply increase is in the nick of time, as we are now starting to see a sizeable migration from Prime to Government in our data. We've seen the shift in portfolio holdings as prime funds prepare to "go Government" but we're about to see it in the reclassification of funds from Prime to Government. Our most recent MMF portfolio holdings data shows that Government Agency Debt increased $34.5B in September to $418 billion, making it the third largest portfolio segment behind Repos and CDs. (Almost half of the gains, $16.7 billion, were due to the ongoing conversion of the $115 billion Fidelity Cash Reserves from Prime to Government.) Money market funds currently hold over $415 billion in Treasury bills and securities, representing 16.2% of taxable holdings.
But this week (and month), we'll see the first big wave of Prime assets become Government fund assets. Franklin funds completed the conversion of about $22 billion in assets from 3 Prime funds into Government funds. The $21.7 billion Franklin Inst Fiduciary Trust Money Market Portfolio, the $1.8 billion Franklin Money Fund, and the $344 million Franklin Templeton Money Fund will be changed in our November MFI XLS, which ships Friday. (These funds are now Franklin IFT US Government MMP, Franklin US Govt Money Fund, and Franklin Templeton US Govt Money Fund.) Also, in mid-November, the $15.7 billion Fidelity Cash Management Prime Fund will be merged into Fidelity Govt MMF, and the $280 million Pioneer Cash Reserves Fund is scheduled to complete its conversion to Pioneer US Govt MMF.
Then on Dec. 1, several Fidelity Prime funds, with assets totaling about $143.7 billion, are due to complete the conversion to Government funds. These funds are the $115.1 billion Fidelity Cash Reserves (changing to Fidelity US Govt Cash Reserves), the $11.9 billion Fidelity MMT Retirement MM Portfolio (changing to Retirement Govt MM Portfolio II), and the $277 million Fidelity VIP Money Market Fund (changing to Fidelity VIP Govt MM). Also in December, American Century will complete the conversion of its $1.4 billion American Century Premium MMF to the American Century US Govt MMF.
