Investors parking cash in the safest of U.S. assets probably won't see immediate relief from depressed returns when the Federal Reserve starts raising interest rates.
The possibility of as many as two rate increases by year-end has failed to outweigh a mismatch between supply and demand for the shortest and safest of debt, with Treasury bill rates maturing through October locked at about zero percent. Global regulatory changes are boosting the need for high-quality assets from bills to repurchase agreements to bank deposits just as the supply is sliding.
"As the Fed begins tightening, yields on all short-term instruments won't recalibrate higher," said Jerome Schneider, head of short-term strategies and money markets at Newport Beach, California-based Pacific Investment Management Co. "There is a misperception in the market that all asset yields will move higher. We are in a new paradigm and there will be these dislocations."
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The demand for such very liquid debt dwarfing supply helped drive four-week bill rates to minus 0.0304 percent on April 29, the lowest on a closing basis since December 2008. The bill maturing on Oct. 1—beyond the September Federal Open Market Committee meeting when economists surveyed by Bloomberg predict the Fed will first lift rates—was at zero percent Wednesday.
Savers would benefit when it comes time to raise rates, Fed Chair Janet Yellen said at a press conference Wednesday in Washington following a meeting of the policy-making Federal Open Market Committee (FOMC). The Fed left rates unchanged, while policy makers signaled they're on track to raise borrowing costs this year.
Ahead of the first policy tightening since 2006, even more money may temporarily flow into the safest of government debt.
"Some core fixed-income investors are just concerned about rising rates," said Peter Yi, the Chicago-based director of short-term fixed income at Northern Trust Corp., which has US$960 billion in assets under management. "As they wait for the market to sell off in longer-maturity instruments, they may temporarily park themselves in cash" and cash-like securities.
Treasury bills outstanding as a share of the government's total marketable debt is about 11 percent, a multi-decade low, and down from a high of 34 percent in December 2008.
On Tuesday, for the third time in eight weeks, the government sold four-week bills at zero percent, issuing $25 billion at that rate.
A mix of post-crisis regulations has boosted demand for repurchase agreements, where investors temporarily lend cash and take in securities as collateral, just as banks are backing away from the transactions as they have become costly as regulators push to shore up banks' capital.
The amount financed daily through the tri-party repo system, where clearing banks serve as middlemen for such deals, is down 17 percent to $1.62 trillion as of May 11 from $1.96 trillion in December 2012, data compiled by the Fed show.
A Fed reverse repo program, which the central bank has been testing since 2013 as one of several tools to manage its eventual removal of monetary accommodation, has provided some relief by giving investors a new place to park funds. Yet strategists say the market's current size, at $300 billion for overnight deals, won't suffice or alleviate downward pressure on rates.
"If we don't get a significant rise in the size of the Fed's program, things will get really ugly late in the year," said Michael Cloherty, head of U.S. rates strategy in New York at Royal Bank of Canada's RBC Capital Markets unit. "There will be a real shortage of bills and repos."
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