Tuesday, May 24, 2011

T-Bills Stay Hot Despite Low Yield

T-Bills Stay Hot Despite Low Yield


Add this to the list of the year's hot investments alongside tech IPOs and precious metals: the lowly Treasury bill.

Dwindling supply and rising demand are causing a squeeze in the market for three-month Treasury bills, considered among the safest investments, that is driving the market up and pushing the yields to the floor.

Right now, the Treasury bills are yielding 0.05% after bottoming earlier this month at roughly 0.01%. That means three-month T-bills with a face value of $1 million bought Friday would earn an investor just over $120 at maturity. It hardly seems worth the effort, but new regulations are making it harder for some investors to go elsewhere in search of higher yields.

They are battling over a dwindling supply of Treasury bills, due in part to the U.S.Treasury's effort to keep the U.S. government's debt under the legal ceiling, which Congress has so far refused to raise.

.As a result, prices of short-term U.S. debt are rising, driving yields, which move in the opposite direction of prices, down to some of the lowest levels since the financial crisis. They have fallen from around 16 basis points, or 0.16%, at the end of January to their lowest point since late 2009.

Treasury bills have been actively sought in both times of euphoria—like the kind that drove LinkedIn Corp. shares through the roof last week—as well as times of worry—as in Monday's stock market selloff. Normally, short-term Treasurys soar during times of maximum fear. The last time rates on bills were this low—late in 2009—and during the financial crisis when yields briefly went negative, investors used Treasurys to protect their assets.

There are several reasons for the low yields: fewer bills being issued, new rules pushing banks to buy more short-term Treasurys and a slowdown in economic growth.

"If people are willing to accept zero yield…that's telling you something," said George Goncalves, head of U.S. interest-rate strategy at Nomura Securities International in New York. "Some of it is a macro story, that there's a belief rates are going to be here for a long time."

After they peak ahead of tax season, government sales of Treasury bills typically decrease around this time of year as tax inflows fill its coffers. But with the debate over raising the debt ceiling dragging on in Washington, the Treasury Department has been rejiggering how it borrows and cutting down on some borrowing.

The Treasury has allowed its $200 billion Supplemental Financing Program to shrink to $5 billion. In that program, instituted during the financial crisis, the Treasury sells T-bills to the public and parks the cash at the Federal Reserve.

The Treasury hasn't yet made any changes to its regularly scheduled auctions of debt. Some changes "should be expected" if the debt limit isn't increased by around Aug. 2, the Treasury says.

"We just haven't seen the type of supply that we would need or expect to keep those rates from dipping," said Ian Lyngen, senior government-bond strategist at CRT Capital Group LLC in Stamford, Conn. "By historical standards, those are extremely low rates for bills."

Economists at Jefferies Fixed Income estimate that $167.5 billion of short-term U.S. debt has disappeared from the roughly $1.7 trillion market this year as it matured. During the same period of 2010, the amount expanded by $41 billion. "We expect that there will be no relief in sight," wrote Jefferies economists in a research note published last week. "Bill supply is likely to continue to dwindle."

J.P. Morgan Chase & Co. fixed-income analysts estimate that $155 billion of Treasury bills will disappear from the market in May and June as they mature.

On the demand side, a rule change by the Federal Deposit Insurance Corp. has made banks less willing to make short-term borrowings using instruments known as repurchase agreements, or "repos," say market participants. Such short-term loans are important investments for money-market mutual funds. With less repo demand from banks, money funds are moving more cash to Treasurys, further increasing demand for short-term U.S. debt.

Meanwhile, money-market funds are adjusting to an earlier wave of regulatory changes aimed at bolstering their safety. New money-fund regulations issued by the Securities and Exchange Commission last year require funds to hold a greater percentage of more-liquid, high-quality assets—typically short-term Treasurys.

On Monday, the U.S. Treasury auctioned off $27 billion in three-month bills at a yield of about 0.055% amid relatively strong demand from investors.

"That's a statement about how the market feels about the yield," said Thomas Simons, money-market economist at Jefferies & Co., adding that the fact that a couple of basis points can coax out buyers suggests they aren't expecting yields to move much higher anytime soon. "These differences have a larger impact on the market," he said.

Write to Matt Phillips at matt.phillips@wsj.com

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