The matter of Treasury Bill supply for the money markets appears to be on the radar of the U.S. Treasury, judging by a recent report prepared for the Treasury Borrowing Advisory Committee. The "Charge 1" TBAC report examines current developments in the market, such as regulations and policy, which have "the potential to change significantly the supply and demand in the market for short-end, high-quality assets where Treasury Bills are centric." This, of course, includes money markets, where the there is concern among asset managers that supply may be strained should the expected migration of assets from Prime to Government take place once the new SEC rules kick in in October 2016. The TBAC report concludes that it should consider increasing the level of T-Bills.
The report says, "Treasury bill supply as a percentage of the total Treasury debt outstanding is currently about 11%, a multi-decade low. At the same time, with $1.4 trillion in Treasury bills outstanding, the total volume of Treasury bills outstanding remains near historically high levels. What are the drivers of potential demand for high-quality, short-dated securities? Given these considerations, should the Treasury either increase or decrease Treasury bill issuance in the coming year?"
On the impact of money fund reforms it says, "Investors are reassessing Prime funds as a liquidity vehicle, with estimates of a $300 billion reallocation from Prime to Government funds. Funds are in the process of announcing changes to structure, most notably with Fidelity re-classifying certain Prime funds as Government funds." It continues, "Money funds by definition and rule own short-duration assets. Bills and short coupons fulfill requirements for assets that offer daily and weekly liquidity."
What are the implications? "Increased demand for shorter-maturity and short-duration Treasury assets, while prime funds no longer offer a true liquidity vehicle. With some funds preemptively announcing a re-designation of prime funds as government-only, combined with expected investor reallocation ahead of implementation, analysts estimate up to $300 billion of potential prime-to-government flows in the near future." It adds, "RRP supply should have a major impact on the demand for bills. RRP also should help re-shape the system in a way that might guarantee strong T-bill demand in the future, especially if the Fed shrinks its balance sheet."
The TBAC says, "In order to satisfy demand and ensure market function, we suggest that the Treasury at least maintains the current level of T-bills outstanding over the next 12 months. This would require either maintaining a larger cash balance or reducing coupon issuance. If possible, the Treasury should consider increasing the level of T-bills outstanding. Otherwise, T-bills outstanding would likely decline over the coming quarters as funding needs will be smaller than cash raised by coupon issuance. Demand for short-term, HQLA is increasing as a result of structural market changes stemming from bank capital rules, 2a-7 reform, and growing clearing/ margin needs. T-bill substitutes are either stagnating or declining in size as a result of developments such as shrinking bank balance sheets or have drawbacks such as failing to offer truly comparable liquidity."
They explain, "These dual dynamics suggest that appetite exists for greater T-bill supply and that there is relatively little risk of crowding out other short-term products. From the Treasury's perspective, increasing T-bill issuance now could help it maintain a larger cash balance and would afford flexibility in navigating uncertain monetary policy periods ahead. The Fed's reverse repo facility is providing a key vehicle for front-end investors, in the event of a stress event or if the facility isn't sufficiently large to absorb funds, potentially overwhelming flows into T-bills and resulting in dislocations."
The TBAC report continues, "The Treasury could approach increasing supply either by increasing current auction sizes or introducing regular 1-week and 2-month issuance. If the Treasury increases current auction sizes, we recommend that those adjustments be made primarily to 4-week and 13-week bills, as structural, regulatory-driven demand is highest for shorter-dated paper. Alternatively, considering new auction tenors could provide additional points of price discovery, enhancing liquidity and avoiding ballooning individual auction sizes, particularly down the road as deficits grow."
Under the subhead, "Pros and Cons of More T-Bill Issuance as a Portion of Treasury Debt Issuance," it lays out the good and the bad. "Pros of issuing more T-Bills: T-bills offer lower borrowing costs for taxpayers on average over time; Demand is likely to be higher as banks' need for short-term HQLA is likely to increase; Demand is likely to be higher as new Money Fund regulations increase demand for short-end government paper; Fewer bill substitutes are likely as outstanding amounts of other short-term alternatives are generally flat or shrinking, which also poses little risk of T-bills crowding out other HQLA; The Treasury could maintain a higher cash balance while maintaining coupon sizes."
The cons: "Rollover risk in the future may be more challenging; If more bills are issued in lieu of long-term Treasury benchmarks, the liquidity of fixed income assets may be significantly reduced; Balance sheet constraints (leverage ratios) may make market making more difficult, subsequently challenging bill liquidity, in particular around quarter-end."
Yesterday's Wall Street Journal covered the news in the story, "Treasury Plans More Short-Term Debt." It says, "The U.S. Treasury Department said it plans to increase the supply of short-term debt, in a bid to ease investors' concerns about difficulty trading in global bond markets. Increasing the issuance of U.S. Treasury bills, which mature in a year or less, likely will be good news for the market for short-term loans known as repurchase agreements, or repos."
The article adds, "Any commitment from the Treasury to keep money markets stable and functioning is a big help," said Kenneth Silliman, New York-based head of short-term rates trading at TD Securities Inc. Treasury's plans to issue more bills comes as there is a growing scarcity of high-quality, short-term debt instruments used widely on Wall Street.... Treasury bills are widely held by the world's most conservative investors, including central banks and money-market funds. A normal functioning of the market is vital to the health of the broad money markets and the U.S. economy."
It goes on, "The announcement from Treasury is partly motivated by their recognition of the important special role T-bills play," said Andrew Hollenhorst, U.S. short-term interest rate strategist at Citigroup Global Markets Inc.." Further, it adds, "Some money-fund managers are skeptical about the effect of the Treasury's plan.... There simply will not be enough government paper" to sate asset managers, said Joseph D’Angelo, head of Prudential Fixed Income's money-markets team."
