Zero Yield 90-Day Bills—-Just Temporary Treasury Cash Sloshing Around The Dealer Market

Thanks to Professor Anthony Sanders for the kind mention in his post about the US Treasury Kabuki Theater. This is an issue that is so crucial to our understanding of markets that I have been covering it in depth every week for the past 13 years. I jotted down a few thoughts in response to his post and a few others I have seen around the web over the past couple of days.

As a result of the debt ceiling there was a $62 billion paydown of outstanding T-bills settled last Thursday. It was the biggest  paydown of Treasury debt that I can recall at least since 2011 when the government paid down $200 billion in SPF funding sitting at the Treasury, put aside out of of TARP cash.

When the Treasury pays down debt temporarily, it literally does a direct deposit into the accounts of the erstwhile holders of the expiring paper, most of whom are Primary Dealers and other large institutions. They are then stuck with no place to go with it because with the paper expired and not reissued, they can’t roll over their holdings. Suddenly they had $62 billion in cash in their accounts, all dressed up with no place to go. We saw the results in stocks, bonds, T-bill discount rates of zero point zero zero and bid//covers at the weekly T-bill auctions that went absolutely through the roof.

I warned before this week that the scheduled T-bill paydown due to settle last Thursday could trigger a market meltup and that T-bill rates would be suppressed. That cash also pushed yields down until Friday, but traders then misinterpreted the stock rally as a signal from stocks to take profits on bond trades. The Primary Dealers also saw this coming. They loaded up their long coupon inventory through most of September. Nice trade for them.

There was supposed to be another paydown this week but the Treasury decided to soak up some of the excess cash floating around and the cash that would have been added to that this week with a previously unscheduled $15 billion Cash Management Bill offering  yesterday. So “No soup for you!” this week.

Treasury Secy. Jackalew E. Looay said that the Treasury should run out of cash the first week of November, which was consistent with my earlier back of the envelope addition and subtraction. The Washington pols will then do a debt ceiling deal under the guillotine, Treasury will restart normal borrowing, supply will come back, and all this silliness will get reversed.

Lather rinse repeat.

Some pundits are misinterpreting the plunging T-bill rates, which went to zero last week, as a buying panic. That’s not the case. I wrote the following note to a friend of ours who had published that opinion with some recognition that supply played a role. But the fact is that there was no buying panic.

I track and report the Treasury supply-demand flows every week. I was just talking to Professor Sanders yesterday about how the market is misinterpreting this issue.

There’s no panic demand. The total tendered for each bill last week was actually at the low end of the normal range. Many of the usual auction participants didn’t bother to bid because they knew the situation. There would be no paper to be had.

Supply has been slashed as the Treasury draws down a massive cash hoard it built up over the course of 2015. It was following a TBAC recommendation for a “rainy day fund.” In reality, this cash kitty was for the purpose of creating a cushion when the inevitable budget impasse, debt ceiling crisis arose.

Last week the Treasury paid down $62 billion in outstanding bills. I’ve not seen a number this big at one Thursday bill settlement since 2011 when the Treasury was in the midst of paying down the special emergency fund it built up from the TARP.

This massive paydown put $62 billion in cash back into the accounts of Primary Dealers and other institutions, who could not roll over the 4 week bills and a CMB that they were holding, which the Treasury redeemed and paid off. The Treasury also reduced the size of the 13 and 26 week bills. You saw the results in the rates crashing to zero and bid covers going through the roof.

But this was all known in advance. I warned repeatedly that with the Treasury against the debt ceiling that it would use the cash hoard to pay down debt as needed to avoid going over the ceiling. Seeing the schedule for last week, I warned that it could result in meltups in all markets. The 0 rates we see are a corollary.

This will all get reversed when the Treasury resumes normal borrowing. In fact, this week it tried to stabilize the situation with a $15B CMB to soak up some of the excess cash, but there should still be a small paydown again on Thursday, and the following Thursday.

The interesting period will be when the Treasury actually runs out of cash in early November.
That’s when a debt ceiling deal has to get done. At any rate, until the Treasury starts borrowing again, the lack of supply is a bullish factor, especially if there are paydowns in a given week.

On the issue of whether there was panic Treasury demand last week, demand was actually lighter than usual! The total bid tendered for the bills was down, but there was an extreme shortage of supply.

The total tender was in the normal range on the 4 week bill at $107 billion on 9/29, which compares with $142, 81, 106, and 121 billion, for the previous weeks.

The 13 week bill bid total tender was low at $68.8 billion compared with $78.9, 76.7, 85.6, and 89.1 billion in the previous 4 weeks.

The 26 week bill bid total tender was low at $65.5 billion vs. $77.2, 79.7, 84, and 89.8 billion in the previous 4 weeks.

At the same time the total bills offered last week of $46 billion compared with $93 billion in regular weekly bills at the end of August plus a $25 billion Cash Management Bill. Most weeks before that, the total weekly bill offering usually totaled $88 billion, give or take $5 billion. They started cutting the offerings in September. By last week, the total of bills offered had dropped to around half the amounts that had been typical in late summer. When there’s that much excess cash around, and no paper to be had, the holders somehow always manage to find mischief to make in the markets. We saw the effects of that mischief making in the behavior of all the markets over the past 5 days.

Cash flows to and from the US Treasury are as important as what the Fed is doing in the market in driving overall market liquidity. You can follow them weekly in our Liquidity Pro Trader updates.