from Follow the Money

The T-Bill conundrum

June 19, 2007

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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10 year Treasuries -- and other long-dated Treasury notes -- usually yield more than short-term instruments.   One widely cited explanation for the fact that until recently longer-term rates were well below the Fed Funds rate: "Non-market" demand from central banks.

As 10 year yields rose over the past couple of weeks, Asian central banks generally stood on the sidelines.   They do not seem to have been big sellers --though the last two weeks custodial data from the New York Fed do suggest some sales of Treasuries and some purchases of Agencies -- but they also weren't big (net) buyers.  Those betting on a strong central bank bid were burned.

But all the cash that is flowing into the coffers of central banks had to go somewhere ...

Societe General has noted that the gap between the interest rate on 3m T-bills and the Fed Funds rate - close to 75 bp at the end of last week -- is exceptionally large. Indeed, the gap is now as wide as it has been during major market disruptions in the past.   The interest rate on 3m T-bills usually is close to the Fed Funds rate.

I strongly suspect that central bank funds that previously were flowing into long-dated Treasuries and Agencies are now flowing into the T-bill market.   At the right rate, I also suspect central banks will once again be willing to snap up longer-term bonds once again.

True, the April TIC data is at odds with a story built around a surge in central bank demand for short-term bills.  But the April data is by now rather dated.  Right now, it sure seems like the central bank bid for longer-term Treasury notes and Agency bonds -- which contributed to the "conundrum" -- has become a central bank bid for short-term T-bills.

Like most, I am drawn to stories that confirm my own suspicions.  But do take a look at the work of Steven Gallager and Aneta Markowska of Societe General.

 

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