Trying to understand a trade that makes no apparent sense is one of the most critical ingredients in portfolio management. Yesterday we had such a trade. The 90-day US Treasury bill was reported to have traded in an auction at a negative yield. That’s right. You bought the instrument at the price indicated and, if you held it to maturity, you got back less money than you paid for it. Diane Swonk summed it up well: “someone paid the government for the right to loan money to it.”
On the surface this makes no sense.
There are plenty of shorter-term interest-bearing pieces of paper that are available and that are backed by the full faith and credit of the United States. So why buy one that is at a negative yield? And, why invest in any fund that is investing in this near-zero-interest paper?
We cannot find a single investor or institution or organization that would volitionally buy this T-bill at zero interest, let alone a negative yield. We have polled firms and agents and portfolio managers. We’ve asked people who range from sophisticated, high-net-worth individuals to multi-billion-dollar institutions. None would do it. We have asked professionals and skilled and trained consultants. All answer “not me.” Foreign currency traders would not do this trade; they have other ways to hedge or structure without buying a negative yield.
Another possibility is market manipulation or a pricing error. Not this time. All evidence points to the negative yield as seeming to be a market-driven price. This is a real puzzle on the surface.
The only explanation we can find is that there are some organizations that are forced to buy T-bills. They function with rules that restrict them from doing anything else. Many of them are foreign institutions.
Others are forced to own T-bills in order to use them as collateral to secure some other transactions. Only a “forced” buyer would pay a negative interest rate to own a 90-day bill. Examples include structures where the T-bill is collateral for an overnight repurchase agreement. For the major institutions that have access to the Fed, this is no longer an issue because they may use the Fed’s portfolio to secure their overnight repos. But those who are not primary dealers and are executing overnight repos could be among the sources of the buying pressure.
Some state funds or other institutional funds also have to be collateralized, and many of those agreements require that the collateral be T-bills. We are familiar with those funds since we use them for some of our governmental clients.
Okay, so we have an explanation, but it is quite limited and we still haven’t found a single firm or agent who will step forward and admit they actually bought a T-bill at a negative yield. Maybe they are embarrassed at admitting it. Maybe this is a real anomaly and there are actually very few intentionally priced trades which took place at this negative yield. Instead maybe there were buyers who were willing to take the average price and then they suddenly found that they came up on the short end of the auction.
Anomalies are important because they are disturbing. When they are not explained, they lead to lots of speculation and innuendo and rumor. They fuel volatility and they add to uncertainty and, hence, increase the uncertainty premium, which is already very high these days.
Is there some role for government here? The answer is yes. The Fed’s research capability in the 12 regional Fed banks and at the Board of Governors could help. They could publish research on why the market traded the 90-day T-bill at a negative yield or why it traded at zero. They could analyze the credit spreads in the shorter-term end of the yield curve and explain why a 2-year Treasury note is trading at a yield of under 1% while an equivalent-maturity federally guaranteed note issued by one of the capital market firms is trading at a yield of 1.75% higher.
In technical terms, the Fed has the resources to dissect the “preferred habitats” that are dramatically impacting the markets and therefore adding to the uncertainty risk premia. This research would be helpful and it could provide explanations for anomalous behavior. If it were available, maybe risk premiums might shrink, and that means credit spreads might narrow.
At Cumberland, and for Cumberland’s clients, both individuals and institutions, we have advised that it is lunacy to buy a 90-day Treasury bill at a negative yield. We don’t own them and would not buy them. This is the time to buy spread product in the corporate sector or the tax-free municipal sector or in the mortgage sector. Risk-averse investors who still think we are going to have the world come to an end, can obtain the federal guarantee without having to buy zero-interest US Treasury obligations. There are plenty of options for you.
Cumberland has some of those investors, and we are managing accounts that carry government-level risk only. We think that is way too conservative a position to take, but our job is to implement a client’s wishes and not impose our own view. We give the client the options. That is the job of a separate account manager
In sum, the negative yield is a true anomaly. We would stay away from it. But, we welcome any reader to offer us an example of an ACTUAL trade in which they or their institution purchased a T-bill at a negative yield and did so fully volitionally and purposefully.
Dear readers: please do not email back speculations. There are many. Please do email back actual examples, if you have them. We will protect the identity of anyone who wants to offer an example and remain anonymous. But we ask that this be an actual trade they have personally confirmed and that it is at a negative yield.