Thursday, December 11, 2008

Negative T-Bills?

I'm on record as saying that I think Treasury bonds have no logical lower limit in yield. While its conceptually hard to be bullish on the 10-year at 2.60%, the threat of deflation completely changes the game.

However, there should be one logical limit on any bond, and that's zero. You can't possibly be willing to lend money to anyone and lock in a loss on the trade. It doesn't make sense.

So when I heard that there were T-Bill trades occurring above par, I was more stunned that Princess Leia aboard the Tantive IV. Who bought T-bills above par? Why would you enter into that trade with a certain loss when you can simply hold currency at no loss?

And don't tell me the dollar is worthless bullshit, because you aren't better off buying dollar denominated T-Bills if the dollar is worthless. Hell, if the dollar was a problem, Treasuries would be cheap, not insanely rich.

Now normally I'd assume that someone got trapped in a short, but who is shorting T-Bills? Seems like an odd trade.

Anyway, if you know how the hell this could have happened, post a comment.

34 comments:

Brian said...

Not only is there the negative yield but the additional transaction costs. The only thing that I can imagine is banks rolling their massive TARP pay-day-loans into the short end of the curve and that the "dude" in the cash management department was instructed to put it all in Bills "no matter what the yield". Bankers have been known to do dumber things. I, with the rest of our desk, spent much of the day yesterday trying to figure out what involuntary technical force could create negative yields and we weren't smart enough to conjure one.

Oregon Guy said...

Say you have a $2,000,000 CD maturing. You can deposit the proceeds in a money market account with FDIC insurance, but the insurance won't cover the $2,000,000 and you don't want the bother of opening a plethora of accounts. Treasuries are bubble-priced, so you don't want to go there. Corporates are shaky because defaults are high and you're risk adverse. You can roll-over the CD, but that opens up the possibility of uninsured loss again.

The 99.99999% safe option for the extremely risk-adverse? Buy T-Bills, even with a slight negative yield. In an unstable, deflationary environment you are just about certain to get the money back and it will be worth as much or more as when you put it in.

If you don't get the money back you need a shotgun, not the cash.

Brian said...

Couldn't you just hold the USD's without paying the negative yield?

ig0r said...

FDIC insurance limits makes "holding cash" not as safe or easy as it sounds.

Also, consider funds want to show they're holding on to safe tbills at year end after being down 40% on the year

a said...

Brian.... where would you put $1MMM?
If you are pimco or any asset manager and you don't want "cash" on hand at C, MS, GS what do you do? FIDC is not going to help you.

I guess you could take actual physical delivery but then what... that is a warehouse of money. Then you have to build a vault, hire guards....OR pay a small vig and roll it in bills...

Irrational Doomsday Blog said...

People don't hold them to maturity. If people think this flight to safety will continue, they'll buy regardless of the yield in the hopes that prices will continue to go up.

It's just speculative buying, if you think people are going to be driving the prices up because of the insatiable demand for treasuries right now, yield doesn't matter.

scott said...

the doomsdayer has a point. yield isn't the only variable making up the return on the bill when the buyer doesn't hold it to maturity.

has anyone looked at T-bill future figures like open interest or broken down any of the catagories to observe recent change? a volunteer would be great. YOU!

Tom said...

Think back to Ec 10...

Given the that the probability of deflation is approaching P=1, there is little, if any, incentive to hold cash, so demand for bonds rises and clears the market and drives the yield to zero. This also means that there is an excess supply of cash. The money market is in a state of disequilibrium.

The LM curve shifts right with an increase in money supply (present), decrease in prices (present), decrease in bonds supplied (not present), decrease in the demand to hold cash (present), and an increase in bond demand (present). All but one rightward shifting factor is upon us.

The use of the IS-LM model might be overly simplistic in this case though, given that:

1 - Stock equilibrium is absent in this market until the economy realizes some significant deflation.

2 - Rightward shifts in the LM curve, driven by the factors noted above, typically result in higher output and lower rates, but currently, despite the myriad of factors causing rightward pressure, output is falling concurrent with rates.

The safety in treasuries outstrips ANY incentive to hold cash.

Irrational Doomsday Blog said...

It has nothing to do with safety vs holding cash, imo. There's actually historic credit risk on Treasuries right now, believe it or not, so it's not because it's safe.

Think of it as a bet, because that's all it is right now.

US Treasury:
Upside, demand is huge, I've seen returns of around ~10% for treasury heavy funds over the last several months while everything else is getting eaten alive.
Downside, worst case, you are the "last sucker" holding the bond as maturity approaches, and you eat no loss or a negligible loss if you bought slightly above par.

Compare that to stocks or corporate bonds right now with the ridiculously high volatility and historically high risk of total default right now.

This is price speculation driving treasury prices, pure and simple. It's not because of the underlying yield. All the yield really does is provide some strong underlying resistance for the price to get too ridiculously high, and the yield to get too negative, especially as maturity approaches.

Sivaram Velauthapillai said...

Japan seems to have had an almost identical situation in 1998. I suspect that the reasons given in the story probably applies to the US case as well.

Brian said...

I dont understand why you would buy treasuries at a negative yield when you can buy pre-refunded municipal bonds which are backed by treasuries, usually. These yields are also tax exempt.

ig0r said...

Brian: liquidity. These are short term cash management tools

Brian said...

I understand liquidity but pre-re's are still fairly liquid.

a said...

anyone distinguishing between cash and T-bills is a complete MORON... one of you brain trusts tell me what the maturities we are taking about here?
If you see the weighted average maturities it is very very short.
Cash= Bills.
Discussions about treasuries (i.e. 10 year paper is another animal entirely)
People are not trading this.. if you want to buy something this is not it..
The impact of delation on 3mth money or cash is the same... so that is not it
Please see my comments above... this is just the cost of funding.

Seriously guys come on

ig0r said...

a: If I'm a company, or a hedge fund, or even a mutual fund; what is cash? where do I store it?

Careful hf's (I can't speak for anyone else right now) don't want to keep excess cash or assets at their PB's anymore. Want some math? Cost of protecting against default is higher than any interest you would earn over 0%. In fact, I'd say its a no-brainer for these guys to go to tbills going into year end

In Debt We Trust said...

Quantitative Easing - the Fed is buying the T-bills in an effort to push investor money into equities.

Mark said...

Even at 0%, Treasury Bills are still the least expensive mechanism for storing cash given the current environment. Where else are you going to stash $100MM and be certain you can get it back? You can't take physical possession without incurring a significant cost and any other USD borrower has a higher risk of default than the Treasury. My firm has resorted to Treasuries for storing cash and so have I personally. Just make sure they are registered in your name (as opposed to street name).

spock said...

Individuals with a Treasury Direct account have the option of choosing the "Zero Percent Certificate of Indebtedness" as a destination for maturing securities.

Up until now this was useful largely for scheduling a purchase on the same day as a redemption, without worrying about the transfer to/from a bank account. Interesting that 0% is now a competitive rate.

Sadly you cannot deposit significant quantities directly into the 0% C of I ... I tried to do this once in order to make a purchase which was larger than the redemption. But the amount was limited to $5000 I believe.

spock said...
This comment has been removed by the author.
Mark said...

Spock: Treasury Direct is definitely the low cost provider for an individual and IMHO a good choice for cash management in this environment. BTW, it is possible to put any amount in your C of I.

REW said...

Could this be related to the fact that the FED pays interest on member bank reserves?
Member banks can buy t-bills, even at a negative yield, hold them as excess reserves, and with the interest paid by the FED, actually come out with a positive yield?

Accrued Interest said...

I promise that people aren't buying 1mo T-bills hoping for capital gains. If the yield goes from zero to -50bps overnight you make... 3bps.

I get all the arguments people are making about a safe storage of cash. But consider this: if I have a prime brokerage account and the broker goes under, am I any safer in CASH (not mmkt) than a T-Bill? Both are covered by the same protections!

Same goes at a bank custody account (not a checking account), right?

Something like Treasury Direct isn't used by investors flinging around $100 million trades. That money is being housed someplace. I just don't understand why you'd intentionally lose money when there is an equally safe option at zero.

Brian is right. There is some weird technical at work here, I'd just like to find out what.

PNL4LYFE said...

Based on what we've learned since the LEH debacle, AI is right about the custody issue. If it's in a segregated account, it should be protected whether it's cash or T-bills. If its in an arranged/levered account that most hedge funds normally use, it's not.

Can't one just look at cash as a constantly maturing Tbill that yields zero? It rolls until you decide to spend it.

Josh Kalish said...

I thought that cash can be lost with a prime broker as you become a general creditor in a bankruptcy. But treasuries are yours. I thought with LEH a lot of folks lost cash.

PNL4LYFE said...

My understanding is that the important difference is not the type of security (or cash), but the type of account. The majority of hedge funds and probably other clients used leverage provided by Lehman. To do this, they used accounts where Lehman had the right to lend securities and otherwise comingle assets owned on behalf of the clients. There is a separate type of account where the assets are segregated and held on behalf of the client; however, this type of account does not allow for leverage.

In the aftermath of Lehman, many people actually read the terms of their agreements and those who could moved assets at other prime brokers to accounts with better protections.

javaman2008 said...

the banks are holding TARP money in Tbills.

Heraclitus said...

I would have thought this would be pretty easy in a deflationary environment actually. Negative nominal yield + deflation = Positive real yield.

Dan said...

The explanation for negative tbill ylds is very simple. It's the only perfectly safe, practical way to hold very large amounts of the currency. Every other alternative involves credit risk or a huge amount of individual fdic insured transactions. Even repos have counterparty risk.

Mark said...

Dan is correct -- there is a difference in credit risk between holding Treasuries in your name versus anything else.

Does your Prime Brokerage agreement stipulate that you money is safe in repos overnight. There is likely a clause that says this is true as long as the repo market is functioning correctly. Are your funds in a segregated account? There is likely a clause that says they can move that money to a non-segregated account at their discretion. Most PB agreements are full of holes that are next to impossible to plug completely.

We learned the hard way after Lehman International transferred $8B (including a few $MM of ours) to Lehman the Friday before filing bankruptcy, that your money is not necessarily safe when things come unglued. And, yes, we have claims pending in both LBI and LEH bankruptcies, but things are not hopeful.

Jake said...

Dan has it almost... the point isn't that is the only safe way to hold cash, cash is just as safe, safer really then a negative return. Cash however is not marginable. T-Bills are the only product that will give you all of your money back plus a small gain (usually, in this case a very small loss) and also release 99% for margin purposes.

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HoosierDaddy said...

Oregon Guy, If you needed to stash more than 250K in a safe asset, why not buy some of the FDIC insured bank debt? Granted there is more potential volatility but you are getting FDIC protection and a positive rate of return.

mojakus said...

Part of the technical at work is inflows into treasury-only money-market funds. The drop below zero is the extra push from 1) forced t-bill buyers (we have accounts that are contractually forced to purchase t-bills for, say, futures contract collateralization), and 2) yes, the credit risk issue - our desk's treasury money fund is not allowed to hold more than 20% in non-govy assets. Uninvested cash remains at the custodian... that counts against the 20% limit.

PNL4LYFE said...

Regarding the TLGP bonds, I believe these are treated much less favorably than Treasuries from a regulatory capital perspective despite the explicit guarantee.