Telemus Weekly Market Review April 17th - April 21st, 2023
In recent weeks yields offered on Treasury bills, or bonds with maturities a year or less, have encountered some odd trading patterns. As depicted in the Treasury yield curve below, interest rates offered have taken on a hump shape as one-month Treasury yields are artificially low at 3.36% and bills with four months to maturity marking the highest point on the yield curve at 5.20%.
U.S. Treasury Yield Curve (as of April 21, 2023)
As interest rates have risen over the past year, Treasury bonds have become more popular among investors given what now appear to be compelling nominal yields. The attraction of Treasury bonds became even greater following the early March failure of Silicon Valley Bank. This event forced bank depositors to revisit where they were holding their cash, and in doing so, also consider the yield they were earning on their balances. This led to a flood of over $500 billion of deposits flowing out of banks and into government money market mutual funds. These mutual funds own a mix of government backed instruments, including a meaningful portion in Treasury bills.
The heightened interest in Treasury bills occurred while the government is looking to manage its liabilities in the face of the looming debt ceiling. As a result of this, the U.S. Treasury has chosen to issue fewer one-month bills, preferring longer maturities. Therefore, the demand for short-term Treasuries, such as one-month bills, has spiked at the same time that the supply of these instruments is falling. This imbalance between supply and demand has resulted in the yield on the one-month Treasury falling from 4.67% to 3.36%, or 1.3%, since prior to the failure of Silicon Valley Bank.
The federal funds rate, or the overnight lending rate between banks, currently sits at 4.82%. Theoretically, one-month Treasuries should trade with yields that offer returns comparable to that of the federal funds rate. The reason being is that banks, money market funds, insurance companies and other institutions that hold cash like instruments can elect to invest in overnight funding options, like intra-bank loans, or purchase short-dated bonds like a one-month Treasury bill. However, given the sizable demand for cash like instruments, there is an insufficient supply of available short-term investment options, which is leading investors to accept lower yields. Hence, this dynamic is causing the unusual shape of the Treasury yield curve.
An added challenge the Treasury yield curve is facing is the looming debt ceiling. The U.S. Treasury has been unable to offer an exact date (i.e., the X-date) on when they will run out of funds to meet payment obligations. A key variable in this equation is the tax deadline that came and went this past week. The amount of refunds versus tax payments into the Treasury, along with first quarter estimated payments, all factor into how long the U.S. Treasury has until they run out of funds. Currently market consensus is that the X-date will occur in the July or August timeline. What we’ve seen in the Treasury market is three- and four-month Treasury bills, or July and August maturities, are the highest yielding as they carry the most risk that the debt ceiling will trip as the time of these bills mature.
What happens to these bonds should the U.S. Treasury run out of funds at the time of maturity? It would be a liquidity issue as the U.S. Treasury would need to prioritize payments. Should they not be able to pay off the Treasury bill, the holder would be without the maturity funds until congress could come to an agreement and raise the debt ceiling. Once that occurred and the Treasury issued new bonds (which could happen in a matter of days), the principal on the bill would be paid and the investor would be made whole. However, this would clearly call into question investors’ willingness to view Treasury bonds as a risk-free asset and could reduce investor appetite to purchase future bonds on fears of future debt ceiling disagreements.
We find the current dynamics in the Treasury bill market to be unique and worth explaining. At Telemus, we are actively monitoring and assessing the optimal short-term investment options for our clients. The best options six weeks ago can be different than what is available today. We encourage you to give us a call if you’d like to talk through the opportunities and considerations across investment options such as savings accounts, bank CD’s, brokered CD’s, Treasury bills or money market funds.
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