Rates have been moving solidly higher in recent weeks, and they should continue higher as the Fed prepares to raise rates again later this week. Treasury bill yields have been leading the charge higher. We quote from two recent pieces on the topic -- Federated Investors' "Rate Watch: Increases aren't just about inflation & Fed hikes", and Bloomberg's "Sea Change Is Underway in Money Markets for Banks, Investors". Federated writes "Yields on U.S. Treasury bills and notes have been rising more than might be expected in a period of still relatively low inflation. We asked two of our portfolio managers responsible for intermediate- and short-term fixed-income strategies, Don Ellenberger and Sue Hill, respectively, for their perspectives."
Hill, Senior PM & Head of the Government Money Market Group, says, "In the last few weeks we've seen yet another chapter in the atypical behavior of the Treasury market since the financial crisis and multiple rounds of Fed quantitative easing (QE). One would expect the shortest end of the yield curve to climb toward the new federal funds target range of 1.50-1.75% that policymakers are widely anticipated to announce next week, and that has been happening. In fact, the 1-month Treasury bill actually has been above 1.50% since the days after new Fed Chair Jerome Powell testified before Congress in late February."
She explains, "But the recent surge in yields isn't just due to anticipated Fed moves -- enormous Treasury issuance also has played a starring role. In addition to the aforementioned reasons (to finance governmental spending and make up for lost tax revenue), the Treasury has wanted to hold a more robust cash-balance position as a matter of prudent policy in order to protect against a potential interruption in market access. Debt-ceiling battles have scuttled previous attempts to build and subsequently maintain this stockpile, so when the debt ceiling was suspended in early February, the Treasury ratcheted up issuance out of the gate as soon as they got the green light."
Hill adds, "For the money markets, it's not just that the Fed is buying fewer bonds as part of the taper but as the Fed holdings roll off, the Treasury needs to reissue to the private sector in order to pay the Fed back. Treasury officials have indicated that a quarter to a third of the total tapering repayments could be reissued in the form of Treasury bills, adding to the supply at the front end of the yield curve. This has pushed repo rates higher and made collateral so plentiful that few participants need to use the Fed's reverse repo facility that sets the floor on overnight trading. As the Fed hikes rates, a key will be that how much the ongoing issuance is absorbed in the market."
Bloomberg wrote last week, "Sea Change Is Underway in Money Markets for Banks, Investors." They explain, "While many fixed-income investors may be focused on the specter of higher long-term Treasury yields, there's a sea change afoot at the shorter end -- in U.S. money markets."
The piece tells us, "The London interbank offered rate, or Libor, and rates on Treasury bills are around levels not seen since 2008. The Federal Reserve's move to tighten policy forms the backdrop for the increase, but an added force behind the surge this year has come from a deluge of supply as U.S. deficits widen. Higher short-term borrowing costs have implications for investors and also for banks, which find themselves paying up to borrow through the commercial-paper market as they compete to lure cash."
Bloomberg quotes Jerome Schneider, head of the short-term and funding desk at PIMCO, "We are in a new paradigm.... The clear focus for the market is where will incremental demand come from to meet this supply." (Note: Schneider will be featured in the "Keynote Discussion: Ultra-Shorts vs. SMAs" at our upcoming Bond Fund Symposium, which is March 22-23 in Los Angeles.)
The article also says, "The Treasury has been jacking up debt sales this quarter: Net issuance is slated to exceed $400 billion, with the bulk coming in bills. The Treasury increased the size of the four-week bill sale to $65 billion, from as low as $15 billion earlier in the year, and bidding has had some difficulty in keeping pace. The bid-to-cover ratio at Tuesday's auction was just 2.58, the second-lowest at the tenor since 2009, while borrowers demanded a yield of 1.65 percent, the most since 2008."
It adds, "For investors, there may be a silver lining. After years of near-zero returns, the rise in rates is boosting demand for money-market funds. Assets in U.S. government-only money funds, which include bills among key holdings, have risen to $2.26 trillion, from $2.07 trillion last year. As the Fed keeps hiking, with the next move likely this month, the influx may continue. But for banks, the increasing appeal of T-bill rates is making them pay up to compete, through offering better returns on the commercial paper they use for short-term borrowing."
Crane Data's Money Fund Intelligence Daily shows our Crane 100 Money Fund Index rising from 1.23% on Feb. 28 to 1.31% as of March 18. Our broader Crane Money Fund Average has risen from 1.07% to 1.14%.
