Friday, November 20, 2009

Are Negative T-Bill Yields Cause for Concern Again?

Yesterday, yields on T-bills that mature early next year traded at slightly negative yields. Amazingly, what that means is that investors are so desperate to park their money in these short-term instruments that they’re willing to lock in a loss on their investment! This is clearly unusual, to say the least. What could possibly behind this seemingly boneheaded investment decision?

There is some speculation that large financial institutions are attempting to “clean up” their balance sheets before the books close for this year by transferring some of their immense cash holdings to short-term Treasury securities. If that’s the case, then maybe it’s no big deal. But, there may be some cause for concern, since the last time this occurred was during the worst of the credit crisis last fall, when distrust among financial institutions was at its peak. Demand for what was perceived as the safest possible investment option – a very short-term Treasury security, which is thought to have no credit risk and virtually no interest rate risk – was so high that it drove prices of T-bills higher, and their already miniscule yields into negative territory. As the crisis has slowly abated this year, yields on T-bills and other securities across the credit spectrum have been gradually normalizing as well, until the past couple of weeks when T-bills have again been in high demand.

After last year’s credit disaster, we regularly review a host of credit market indicators and relationships. So far, the action in T-bills isn’t being reflected in other areas, like credit spreads or LIBOR rates, which were under tremendous pressure a year ago. Therefore, we aren’t too concerned yet, but we’ll certainly be paying close attention to see if other signs of possible stress reappear.

Chart – Generic 3-month Treasury Bill Yield