The T-Bill conundrum
10 year Treasuries — and other long-dated Treasury notes — usually yield more than short-term instruments. One widely cited explanation for the fact that until recently longer-term rates were well below the Fed Funds rate: "Non-market" demand from central banks.
As 10 year yields rose over the past couple of weeks, Asian central banks generally stood on the sidelines. They do not seem to have been big sellers –though the last two weeks custodial data from the New York Fed do suggest some sales of Treasuries and some purchases of Agencies — but they also weren't big (net) buyers. Those betting on a strong central bank bid were burned.
But all the cash that is flowing into the coffers of central banks had to go somewhere …
Societe General has noted that the gap between the interest rate on 3m T-bills and the Fed Funds rate - close to 75 bp at the end of last week — is exceptionally large. Indeed, the gap is now as wide as it has been during major market disruptions in the past. The interest rate on 3m T-bills usually is close to the Fed Funds rate.
I strongly suspect that central bank funds that previously were flowing into long-dated Treasuries and Agencies are now flowing into the T-bill market. At the right rate, I also suspect central banks will once again be willing to snap up longer-term bonds once again.
True, the April TIC data is at odds with a story built around a surge in central bank demand for short-term bills. But the April data is by now rather dated. Right now, it sure seems like the central bank bid for longer-term Treasury notes and Agency bonds — which contributed to the "conundrum" — has become a central bank bid for short-term T-bills.
Like most, I am drawn to stories that confirm my own suspicions. But do take a look at the work of Steven Gallager and Aneta Markowska of Societe General.
Brad,
That’s a good reference summary. Appreciate it.
The only move that surprised me in the currency markets was the Euro. That was a big slide. I haven’t read a good explanation that satisfies me on that level of movement in such a brief period. Probably available, but I have missed it obviously.
Has Hank Paulson had much to say about any of the events of the past few weeks? Yeah, I am not keeping up as I should.
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Brad, I am looking to sell everything at the moment except maybe the US dollar. I think everything looks toppish up here. Crude looks overbought. So does the S&P energy index as well as the S&P500 itself. EURJPY looks like its poised for a retracement from 166 to 162-160. I would not buy UST near 5.00%. I still believe in the yield steepening play. The Russian RTS looks terrible, especially in light of comments by Fradkov that the government would look to claw even more revenue back from exports, and Lukoil’s Fedun who see a big production short-fall. The resource based RTS is looking heavy, so if crude slides as well as western oil cos. then the RTS has only one direction to go and that’s down. Ironically, for me at least, is that I see the USD gaining some ground against the EUR, especially if EURJPY corrects lower, and see us back towards $1.3200 again. I think that the end of the quarter will see a steep sell-off that might turn into our summer of discontent? We’ll see? So whatever central bank funds are flowing into the market I would also prefer short-term money market to be honest. Cheers.
“…With state-owned corporations operating in a free market economy, it is a different story. It is like setting up bottomless money pits with direct lines to private accounts in Geneva banks…” http://www.moscowtimes.ru/stories/2007/06/20/007.html
That the TED (T-Bill/eurodollar) spread has also widened is some small evidence that Voldemort et al have snapped up the very short end of the curve. Why is this? It could be that they are market timing the back end; certainly the aggressive intraday buying of the back end last week would suggest that they simply wanted to receive more compensation for taking duration risk than they had done in the past. An alternative explanation is that China in particular knows that it will be selling some of its reserve assets to the SWF soon, and so is putting fresh reserves into the very short end so as to transfer the securities to the SWF, who will then deploy the cash at the maturation of the securities.
The banter among the folks that I know in the business of exporting from the EU to the USA (none of whom are economists, BTW) is that they are expecting some strengthening of the US$ as Bush’s mandate winds down - for reasons that may be self-evident.
Considerable volatility and even some passage of time in the pattern of the long end deterioration. Is it quite likely in your view that the CB reaction was truly astute in its timing (versus late for example - i.e. moving into bills following most of the rate rise)?
Macro Man,
If Voldemort intends to assign dollars to other investments in the near future, wouldn’t it make more sense to just keep them on deposit?
I am skeptical of the argument that SAFE needs to pile up cash in t-bills to transfer to the SWF (SFEIC) …
a) China has a substantial incoming monthly cash flow — $30-40b a month. 6m *30b = 180b, or about what the SFIEC supposely will get
b) I would suspect that the SFEIC won’t issue all the RMB bonds needed to buy the fx from SAFE at once, so there will be a gradual buildup.
Just a guess tho.
Rumor is that “Asia” (China i assume included) resumed buying longer-dated bonds this week, after taking the previous 2 week off …
incidentally, if all the fx going into China in the second half did go to SFEIC to build up $200b in a half a year, that woudl be a big shift in flows — money that used to go to bonds will be going into whatever the SFEIC buys. Doing it out of stocks = same effect if the SFEIC is given $ cash (or maturing t-bills) rather than some of SAFE’s long-dated bonds.
Within a year, the growth of SWF and their investment in markets may be the big story. As a resut maybe DOW 25,000 in two years or so? I forsee many bears getting badly burned. I also see a major rally in 10 year treasuries, starting now and lasting for more than 18 months. Going into major elections in 2008, the powers that be cannot allow a further steep rise in longer term interest rates; which would lead to further weakness in the housing market.
Brad, RE, my understanding from discussions with people more closely connected than I to China and Lou Jiwei is that the SWF will buy physical securities, rather than cash or deposits, from SAFE, and invest the money in ’sexy’ assets as those securities mature. If this is correct, then it could well make sense to buy ultra-short dated bills ahead of the handover. I would agree, though, that China appears to have market-timed the US bond market as Brad suggests above. If SAFE et al start treating government bond markets like they do currencies, then expect to see a lot of unhappy bond managers out thre over the next few years….
I wouldn’t say that SAFE has marked timed the move so much as not stood in the way — i.e. it doesn’t seem to have come in and bought large quantities of longer dated bonds as the market was moving. now that things have stabilized a bit, i suspect that they are buying. handing over s-term t-bills has some advantages, tis true — but at the margin, handing over a liquid t-note would work too - SFEIC could sell it for cash/ do some kind of swap to free up funds for sexier assets.
Interesting information, Macro Man!
I don’t find this explanation entirely satisifying. I find it difficult to square with basic term structure theory. Changes in the shape of teh yield curce should be associated with either changes in expected interest rates or with changes in term premiums. I don’t think central banks could drive the shape of the yield curve sharply out of line with what is consistent with expectations and required term premiums. They are big players, but not that big.
From a different perspective: If central banks could alter the shape of the curve (which I doubt), and if they were were piling into bills, then the twisting would be concentrated in the bill sector with little twisting throughout the coupon sector. However, the coupon sector also has twisted — look at the 10-2 spread.
A more likely explanation: market participants now have different expectations for the economy and interest rates. With the economy picking up and the Fed no longer expected to ease (many now looking for tightening), expectations of future short-term interest rates have changed, and hence the shape of the yield curve has changed.
Let me lift my post from another blog:
Do look at the results of the most recent 10-year note auction more closely. If you inspect this series in recent years–say after the 2001 recession–indirect bidders usually get 80% or more of their bids awarded. Indirect bidders, of course, are the category which includes official buyers.
What happened in the auction on Jun 12? Only 34.3% of indirect bids were awarded meaning that, conversely, nearly two-thirds of indirect bidders
put in bids for yields higher than 5.23% (They may have put in some noncompetitive bids, but they rarely do.) Primary dealers, who almost always get a lower percentage of bids awarded, actually got a higher percentage awarded here (39.4%).
It’s just one auction, but should this trend continue, there’d be only one possible explanation–indirect bidders are no longer content with el cheapo rates from Sammy. Hence, rising yields on the long end of the yield curve.
Backing off on an auction doesn’t necessarily mean those who missed are price makers. Quite the contrary. It may mean they’re risk averse in the short term, but price takers in the long term - back in the auctions at normal participation levels if/when volatility recedes.
There are some good technical comments, but few conclusive explanations. Why isn’t it fairly obvious as to what happened? Who’s in the back room making the swing moves? Which central bankers? Which hedge funds? Which whomever else?
I agree with Kater’s observations [Kater on 2007-06-20 14:23:51] in his first two paragraphs. I made that observation last month with friends as the developments unfolded.
The size and speed of the interest rate movements during from May 10th to the first week of June still surprised me.
How did New Zealand’s interest rate moves fall out of the discussion?
I don’t see why the subsequent release of the May 9th FOMC meeting minutes caused any concern. Yet, I had more than one banker tell me that bank prime interest rates would rise quickly due to inflation concerns. I looked at each them as if they were nuts. The FOMC meeting minutes were being treated as if the Fed had just made another move, though this was weeks later. Overnight, the rates rocketed up. Why?
Someone explain that if they can.
Then explain the resurgence in global economic growth from the first quarter. And why New Zealand is having inflation problems, other than it’s renewed popularity for relocation.
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Tater — if expectations about the fed have changed, how would you explain the low yield on t-bills observed at the start of this week? it is hard to square t-bills trading at yields below the fed funds with the of expectations that the fed will ease –
and i think you may be underestimating just how much central banks are buying — they basically now buy the treasury’s net issuance, and recently, their total demand for “safe” us securities has topped the issuance of treasuries and the agencies own debt.
i agree to a degree with guest’s comments about central banks not buying amid a lot of volatility, though i would argue that not buying makes one a price maker if the absence of an expected source demand ends up changing others views about the market.
and in any case, someone is (or was) making a price of t-bills that was well below the fed funds rate …
Brad - fair assessment of auction results and CB influence. Perhaps the interpretation is somewhat malleable, given behavioral considerations. But I was interested to see the composition of the results referred to by Emmanuel above:
http://www.publicdebt.treas.gov/of/releases/2007/ofstats0612200702.pdf
Emmanuel’s point, a good one, was that successful (i.e. accepted) indirect bids were unusually low relative to tendered bids, and indirect bids include official buyers.
I don’t follow auction results closely, but its also interesting to note that indirect bids tendered (i.e. interest at some price) were only 12 % of total bids tendered.
I wonder how this ratio compares to the norm, because it seems low at least at this auction, relative to an intuitive notion of CB involvement generally in the market. It doesn’t seem to point to outsized marginal pricing influence, even if the full indirect tender had been accepted.
This ratio compared to the norm might also give additional sense as to the offical interest (at some price) at this particular auction relative to the norm.
Also, it raises the general question as to the mix of CB sourcing of teasuries - at the auctions or in the secondary market.
T-notes. Time to buy?
There is an important implication of my ( http://inflationusa.blogspot.com/ 0
long-term prediction of inflation in the USA.
In 2007, inflation, as measured by GDP deflator, will be approximately +3.1% +-0.4%. This is the highest value during several previous and many future years.
In 2012, inflation will drop below zero, i.e. a deflationary period will start. It will be observed for 5 to 8 years.
Therefore , a safe long-term investment would be in 10- to 15-year T-notes, or 20-year T-bonds.
Having about 4.5% coupon rate and negative inflation one can expect a stable and relatively high cash flow, if to consider other economic circumstances related to deflation. Real economic growth should not be too strong, as Japan have been demonstarting the last 15 years.
Also, the best time to buy is the end of 2007, when their price will be far below par price.
For obvious reasons, I would not recommend TIPS.
Another explanation for the low level of bill rates is the paydown by the Treasury. Treasury began paying down bills in April because of heavy tax receipts, and paydowns in June have been substantial as well. The Treasury will probably begin raising new cash in the bill market in July and bill rates will probaly move into closer alignment with the fed funds rate at that time
Kater - sounds more like the real explanation.