The Treasury Borrowing Advisory Committee (TBAC) first proposed the idea of folding a new 2-month T-bill maturity into its weekly auctions of 1-, 3- and 6-month bills back in May 2015. Since then, the topic has been hotly debated and the Treasury has carefully analyzed the factors that could determine its success or failure. These include potential investor demand for the maturity, changes to existing auction sizes, operational and settlement risks, and possible liquidity constraints that could arise from a proposed alternative settlement date.
At the Treasury’s quarterly refunding meeting in May 2018, the TBAC appeared resolved to issue the new bill, touting its potential benefits. Indeed, the idea has generated strong traction given the projected increase in the government’s borrowing needs over the next several years1 and ongoing strong demand for Treasury securities among US and foreign investors.
Invesco Fixed Income believes the introduction of the new T-bill makes sense for the Treasury and investors, and that it will fit smoothly into the existing T-bill market. We expect the new T-bill to be introduced late in the third quarter or early in the fourth quarter of this year as the Treasury ratchets up debt issuance to meet rising financing needs.
What would be different about the 2-month auction?
Current weekly auctions of 1-, 3- and 6-month T-bills settle on Thursdays (except for holidays, when settlement occurs on Friday). The Treasury is currently reviewing the operational efficiency of settling the 1- and 2-month auctions on Tuesdays, with the intention of reducing the concentration of T-bill issuance on Thursdays.
Why is the Treasury proposing this now?
The government is considering ways to finance its growing budget deficit with increased borrowing, including potential increases in net T-bill issuance in the coming years. The Congressional Budget Office projects that the federal debt will rise steadily over the next decade, driven primarily by tax and spending legislation enacted in December 2017.2 A new 2-month T-bill could help reduce upward pressure (due to growing supply) on existing T-bill yields by spreading auction sizes across more maturities. A new 2-month T-bill could also allow the Treasury to manage its target duration more effectively and take advantage of lower funding costs associated with shorter-maturity T-bills.
Money market reform has also generated increased demand for T-bills as assets shifted from prime to government money market funds. We believe the introduction of a 2-month T-bill would likely be a good fit for money market investors who are required to maintain a weighted-average maturity of 60 days or less.
How it could impact Treasury investors?
The introduction of the 2-month T-bill, coupled with potential modifications to 1- and 3-month auction sizes, may change the dynamic of the T-bill curve (aside from pressures arising from debt ceiling constraints or impending rate hikes). On balance, it could boost Treasury yields in the 2-month maturity bucket during periods of additional supply. In instances where short-dated T-bills yield more than repurchase agreements (repos), there may be an opportunity for money market funds to reallocate from repos into T-bills to gain incremental yield.
The biggest adjustment for Treasury investors will likely be changes in the settlement day of the 1- and 2-month T-bill auctions. We do not expect this alternative settlement cycle to disrupt the T-bill market given its high level of investor demand and ample liquidity. However, we have observed instances in which T-bills settling on alternative dates have been issued at slightly higher yields compared to others of similar maturity.
For example, a 14-day cash management bill that was auctioned in July 2017 settled on Tuesday, Aug. 1 with a yield of 1.01% — higher than the 0.99% yield on that week’s 1-month T-bill auction, which settled on Thursday, Aug. 3.3 Over time, we expect investors to adjust to the new settlement cycle, and believe any upward pressure on yields will likely be temporary.
Invesco Fixed Income believes a 2-month T-bill auction is a positive addition to the Treasury’s current lineup and is unlikely to create market disruption. Benefits to the Treasury include diversification of its auction schedule, improved short-term debt management and the avoidance of “oversizing” a particular T-bill issue. An alternative settlement date also reduces the operational risk of congested settlements on one day. For market participants, the new T-bill may provide greater flexibility in managing and constructing portfolios and may allow investors to take advantage of any temporary dislocations that occur at the front end of the T-bill curve.
1 Source: US Department of the Treasury, Minutes of the Meeting of the Treasury Borrowing Advisory Committee, May 2, 2018
2 Source: Congressional Budget Office, The Budget and Economic Outlook: 2018 to 2028, April 9, 2018
3 Source: TreasuryDirect website, data as of May 10, 2018
The iShares Barclays 1-3 Year Treasry Bnd Fd (SHY) was unchanged in premarket trading Friday. Year-to-date, SHY has declined -0.67%, versus a 2.23% rise in the benchmark S&P 500 index during the same period.
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