Treasury Secretary Janet Yellen is facing a conundrum that, at first glance, might hardly seem like one at all. Investors may soon be willing to pay more than 100 cents on every dollar for U.S. Treasury bills. But current rules won’t allow it.
The main reason for these restrictions is that if the Treasury accepted such a high price, it would effectively be issuing — and perhaps tacitly endorsing — negative-yielding debt. T-bills don’t pay interest but rather are sold at a discount to their face value, which provides a modest yield for investors. That discount has disappeared slowly in auctions this year: Four-week bills were sold at 99.993778 cents on the dollar on Jan. 7, then 99.994167 cents a week later on Jan. 14, then 99.994556 cents, then 99.995722 cents, and finally 99.997667 cents in the past two weeks. The respective yields on those sales: 0.08%, 0.075%, 0.07%, 0.05% and 0.03% (twice).
Some interest-rate watchers expected those figures to hit their limits on Thursday: 100 cents on the dollar, for a 0% yield. While that didn’t happen, the race to zero will likely only intensify in the coming weeks. The reason this is happening, as I’ve written before, is a supply-demand mismatch stemming from the Treasury’s need to reduce its near-record cash balance in the next several months to abide by federal debt-ceiling rules. The bond market got new details of exactly how it would go about doing that earlier this month, when the department announced it would stop selling 15-week and 22-week cash-management bills after last week’s round of auctions.
Without those offerings to soak up some demand, it follows that investors might be willing to buy T-bills with shorter maturities at prices above 100 cents on the dollar. Given the huge size of the Treasury’s auctions — $30 billion of four-week bills, $35 billion of eight-week bills — this could quickly add up to a potentially sizable windfall for the federal government. If those two auctions could even just price at 100.01 cents on the dollar, the Treasury would stand to earn about $6.5 million.
Now, in the grand scheme of the U.S. budget, even millions of dollars a week would barely register as a blip. The federal government is running multitrillion-dollar budget deficits to combat the economic fallout from the Covid-19 pandemic. Still, amending the rules for T-bill auctions certainly seems to be as close as the Treasury can get to “free money,” or what former President Donald Trump last year called a “GIFT.”
The Treasury isn’t blind to this possibility. During the worst of the market meltdown last March, when T-bills were auctioned at 0% and traded at negative rates in the secondary market, Bloomberg News’s Liz Capo McCormick and Saleha Mohsin published a scoop that included this interesting passage:
“The Treasury absolutely, categorically, right now has to be thinking about this,” said Seth Carpenter, an economist at UBS, and a former Treasury official and adviser to the Fed. In the current situation, “you are essentially just transferring wealth to other people. The Treasury is in a bind and they have to make a decision on this with bill rates being negative as they are.”
The systems are already in place. In 2015, when bills also traded at persistently negative levels amid supply cuts to keep the U.S. under its statutory debt limit, Treasury adjusted its systems to allow it to handle a negative auction rate, according to former Treasury officials familiar with the matter. However, it never followed through and changed its policy.
So if it truly is just a matter of flipping a switch, should Yellen give the go-ahead?
It’s a tricky question. I’ve long argued that the Federal Reserve would be foolish to cut its benchmark lending rate below zero, and I’m still convinced that doing so would be a terrible mistake. U.S. central bankers, for their part, have said it’s not a policy tool they envision using. But that’s not exactly the question at hand. Nevertheless, former Treasury officials and staff members told McCormick and Mohsin last year that allowing sub-0% rates on T-bill auctions might confuse that messaging and signal to investors that negative rates are here to stay.
If any combination of Treasury secretary and Fed chair knows how to manage bond-market expectations, though, it’s Yellen and Jerome Powell. If T-bill auctions were allowed to price with negative rates, and Powell was asked about it, it’s easy to imagine him reiterating that the central bank views it as a temporary phenomenon tied to parameters around the federal debt ceiling and that he and his colleagues see no reason to lower the fed funds rate any further. Bond traders would be welcome to push him on that, but they’d be fighting the Fed at their own peril.
Yellen and Powell might also be willing to take the risk of allowing negative-yielding T-bills because the alternative isn’t exactly palatable. The way things are trending, the Fed will have to raise its interest rate on excess reserves, known as IOER, from 0.1% within the next month or so to prevent persistent pressure on the zero lower bound from short-term rates. Powell will undoubtedly stress that such a tweak should not be misconstrued as tightening monetary policy, and while there’s certainly validity to that argument, at the end of the day it’s still the central bank lifting short-term rates.
The elephant in the room, to be sure, is the $4.3 trillion money-market fund industry, which would prefer to keep T-bill rates at 0% or higher. State Street Global Advisors published a report in June that detailed some of the options available to money-market funds if the Fed opted for negative rates. State Street suggested they would resort to a “reverse distribution mechanism,” which periodically removes shares from an account, or allow for “variable net asset values,” meaning the fund’s price would slowly sink.
But this is not a question of the Fed endorsing negative rates, just the Treasury selling T-bills at the going rate in the secondary market. State Street noted that “the majority of money market funds have the ability to invest in repo or government agency debt,” providing some alternatives for when T-bill rates hit zero. The Fed, for its part, has a number of tools at its disposal to manage repo markets.
The biggest hurdle might be politics and perception. Even though there’s trillions of dollars of debt with negative yields across the world, effectively paying the U.S. government to hold Treasuries would be something new. Investors big and small would feel the pinch if money-market rates fell below zero. Even if they’re already losing money on inflation-adjusted terms by sitting in cash, there’s something personal about crossing a nominal threshold like zero.
Ultimately, I don’t see Yellen rocking the boat and allowing for negative-yielding T-bill auctions. But I wouldn’t have a problem if she did, especially if secondary-market rates stay at or below zero for an extended stretch. Carpenter, the UBS economist, was right when he said last year that current rules just pass along profits to dealers who get their hands on an auction allotment. As strange as it may seem for the U.S. government to pass up what looks like free money, the potential unintended consequences might have too high a cost.