Concerns that payments on short-term Treasury bills would not be met caused investors to exit the market in early October: total outflows from money-market funds reached almost $54 billion in the first two weeks of the month. "The dislocation became so bad that one day the October 17 paper was yielding 50 basis points at moments. Last month yields were close to zero. Rates were extremely volatile," says the head of trading at a US bank.
The US Treasury had estimated that the country would hit its $16.7 trillion debt limit on October 17, leaving it with about $30 billion to meet its obligations. According to analysts, that would last for just two weeks, beyond which defaults would begin. Inconceivable as this prospect might have seemed, investors were taking no chances. Fidelity and JPMorgan Investment Management were among those to announce that they were selling October 17 bills. Some $120 billion was maturing on October 17. In a statement, JPMorgan said its money-market funds no longer held any treasuries that would mature or have interest payments scheduled between October 16 and November 6.
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According to analysts the exodus was driven less by fear of no payment than by concerns about timing of payments. "If the Fed didn’t extend the maturity of the short-term bills and the debt ceiling had not been increased, then the cusip [identifier] would be gone and the holder would be left with a receivable that could not have been settled over the Fed wire," says Stuart Sparks, fixed-income strategist at Deutsche Bank in New York. That was less of a deterrent to long-term holders such as Pimco, which were reportedly buying up the short-term bills. "The sellers like Fidelity were price insensitive and just needed to sell, whereas buyers like Pimco were unconcerned with redemptions," says a rates trader. He says the pick-up was incremental and only "mildly profitable". Yields have now returned to normal, although Citi research predicts "slightly higher short-term rates as investors stay allocated to liquid bank deposits rather than short-term paper."
Sparks says that some clients were asking to amend their collateral agreement so as to not be delivered short-term bills. "The size of the Treasury collateral market is so large that it doesn’t have a significant impact, but it raises interesting questions," he says. "If in an emergency situation there is no desire to hold short-term bills, then who in the end takes the risk? The Fed would have to get involved to maintain a liquid and orderly market. Will haircuts on these repo agreements go up? Thus far, no. Could they trigger mark to market of existing collateral? Certainly if there had been a missed payment there would have been a margin call. I think there will be caution by investors."
The ‘soft’ debt ceiling has been raised until February 7, but Sparks says it is May redemptions that will be making investors jittery. "The cash wouldn’t run out until May, so investors are likely to become sensitive to holding bills that mature in May – they will be hot potatoes."
Andrew Hollenhurst, rates analyst at Citi, says he is expecting the cash to run out in mid-March. He says the US government is likely to want to push back the ceiling into April, however, to align with the tax season. The final tax-filing date in the US is April 15. In February and March those expecting tax repayments from the US government tend to file early while those owing the US government tax money tend to leave it as near to April 15 as possible. "If there were surprising low spendings in revenues to early filers and high revenues coming in from taxpayers that could change the whole scenario," says Hollenhurst. "But we think mid-March will be as far as the hard ceiling can be pushed."
It is expected that investors will have the same reaction over that period as they had this time. Compared with 2011, some analysts say this year’s reactions happened earlier although there was less panic that the payments would not be made. And although rewritten collateral agreements have been returned to their originals, the operation and legal tasks and costs involved mean that tri-party agents are likely to try to be more prepared for February.
A head of rates trading says greater concerns have arisen from the lack of political cohesion around the debt ceiling. "It seems as if many global investors are uninterested in the games that the US government is playing. The volumes over the first two weeks of October were extremely muted across the entire swaps and treasury curve. The risk is so out of control – you can’t have a view on what a few nuts in Washington will decide. The reason why the US Treasury market has performed so well is that on a relative basis it continues to be a top credit. But there are other places that investors can put their money – lots of other places. In the end, the US government could really kill off investor appetite if it doesn’t get its act together."
