While many are focused on whether U.S. federal spending hits the debt ceiling before a deal is reached to increase it, that scenario is only part of the story in the U.S. Treasury bill market.
Over the past few trading sessions, T-bill investors finally woke up to the fact that the date for hitting the debt ceiling (projected to be 3 November) is fast approaching. Until this week, T-bill yields in the maturities most affected by the debt ceiling had been trading in-line with non-debt-ceiling maturities. Now, however, these issues have cheapened, and yields have risen by five to 10 basis points compared to “non-debt-ceiling” issues.
This repricing to higher yields reflects investors’ fears of delay in payment on the (potentially) affected securities. While headline worthy, this pales in comparison to what we saw during 2013, when the so-called “debt-ceiling bills” cheapened by as much as 70 basis points. Until the debt ceiling is resolved, we will likely see more headlines and more cheapening of early to mid-November T-bill yields.
More importantly for investors seeking to preserve capital or manage cash via the use of T-bills, such headlines mask the many underlying problems affecting the T-bill market, which we believe are even more interesting. One problem is the tremendous supply/demand mismatch for short-dated assets. Another is the ripple effect of regulation, which has reduced dealer ability and willingness to provide liquidity on the other side of “debt-ceiling-bill” sales.
Once the debt ceiling is resolved, we will be left with a market still experiencing lower liquidity, a dwindling supply and increasing demand driven by 2a-7 regulation on money market funds, banking regulation and collateral requirements. All of this demand will keep T-bill yields near zero for the foreseeable future, and even after the Fed increases its policy rate T-bill rates will likely remain at depressed levels, possibly even near zero.
Investors should look beyond the headlines and noise around the debt ceiling and pay more attention to this fact. Cash investors who hope to earn more than zero will need to look outside traditional liquidity investments (such as Treasury bills and money market funds that hold them) toward alternative cash investments that can offer higher yields with only slightly higher risk. These may better enable investors to keep pace with Fed rate hikes, proactively manage their liquidity and attempt to reduce their exposure to increasingly volatile markets.