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Analysis: U.S. race to clinch debt sales may prove costly

A general view of the U.S. Federal Reserve building as the morning sky breaks over Washington, July 31, 2013. REUTERS/Jonathan Ernst
A general view of the U.S. Federal Reserve building as the morning sky breaks over Washington, July 31, 2013. REUTERS/Jonathan Ernst

By Richard Leong

NEW YORK (Reuters) - It sounds like the plot of a pulpy Hollywood thriller: a mad dash for more than $100 billion in cash in the 48 hours before the clock runs out.

Except in this case, the U.S. government is racing, and the money would come from normally staid, uneventful sales of short-dated Treasury bills.

While President Barack Obama said on Monday that lawmakers appear to have made progress on a deal to reopen the government and avert a looming debt default, it is unclear how willing investors will be to fork over money in exchange for Treasury bills until an agreement has been passed by both the Senate and the House of Representatives.

The Treasury Department said it cannot guarantee the U.S. government will be able to pay its bills past October 17 if Congress does not raise the $16.7 trillion debt ceiling by then.

Concerns about a possible default caused investors to pull more money from short-term money market funds last week than at any time since the last debt ceiling crisis in August 2011. Overnight costs for loans secured with these bills have also risen, straining a key source of ongoing funding for banks.

The nervousness will likely result in the Treasury paying higher interest rates for this week's borrowing.

"If I were running some of these money market accounts, I would say ‘No way, Jose' - I am not going to bid in this auction because I could be buying a potential default," Dan Fuss, vice chairman and senior portfolio manager at Loomis Sayles, said in an interview on Monday.

The Treasury Department will sell $35 billion in three-month bills and $30 billion in six-month bills on Tuesday. It will auction $22 billion of one-year bills and a yet-to-be announced amount of one-month T-bills on Wednesday, which in recent weeks has ranged from $30-$35 billion.

As of last week, Wall Street firms and money market mutual funds had reduced their holdings of T-bills, or at least shunned buying more, if they matured in the remaining months of the year on fears the government might delay debt payments for the first time since the 1970s.

This has caused a spike in interest rates on T-bills that mature before the end of the year to levels not seen since the height of the global credit crunch nearly five years ago. Those yields are low - just 0.15 to 0.25 percent - but they are still double or triple the interest on those bills just a few weeks ago.

Large investors pulled $19.87 billion from money market funds that focus on Treasuries and government-related debt in the week ended October 9. This was the largest asset drop for institutional taxable government money funds since the week ended August 3, 2011, the Investment Company Institute said last week.

At the end of August, U.S. money market funds held almost $100 billion of T-bills that mature between mid-October to mid-November, accounting for about 17 percent of the holdings of Treasuries in money market funds, according to J.P. Morgan Securities.

Primary dealers, those Wall Street firms that do business directly with the Federal Reserve, have slashed their holdings of T-bills. In the week ended October 2, their net long positions in T-bills fell to $16.2 billion, less than half the amount two weeks earlier and the lowest level in about a year, data from the New York Federal Reserve showed.

"In our view, this clearly reflects concerns over the impasse on the debt ceiling," said Kam Poon, portfolio manager with Aberdeen Asset Management, in a research note.

Last week, interest rates on one-month bills ended at 0.26 percent after they briefly traded above 0.50 percent, higher than the yield on a two-year Treasury note.

"Many participants have already cut exposure to front end issues, which is likely to have a negative impact on auction proceedings," said Gennadiy Goldberg, interest rate strategist at TD Securities in New York.

So far, longer-dated bill rates have stayed put. The three-month, six-month, and one-year bill rates are trading between 0.07 percent and 0.13 percent, according to Reuters data.

A week ago, the Treasury Department sold $30 billion of one-month debt at an interest rate of 0.35 percent, the highest yield since October 2008. The total amount bid relative to the size of the sale came in at a ratio of 2.75 to 1, the lowest in about 4-1/2 years.

"We could see a similar progression this time, which could send fresh shudders through the market," said Goldberg.

The surge in one-month T-bill rates has increased other key short-term borrowing costs. In the $5 trillion repurchase agreement market, interest rates for banks and Wall Street firms to raise overnight cash jumped to 0.25 percent last week before retreating to 0.18 percent. A week earlier, overnight repo rates were at 0.09 percent.

Tempering some concerns, analysts said that even if rating agencies downgrade any T-bills and other Treasuries to "selective default" status due to delayed payments, money market funds are not required to sell them.

"There is no requirement to liquidate upon default, with the decision being left to the boards of directors of individual funds," Aberdeen's Poon said.

Without forced selling, money markets where banks and Wall Streets fund their day-to-day operations should keep operating without major disruptions, analysts said. Still, investors who buy these bills are going to demand more yield, no matter how small the increased risk.

(Reporting by Richard Leong; Additional reporting by Jennifer Ablan; Editing by Richard Chang)

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