NEW YORK (Reuters) – The safe-haven reputation of U.S. Treasury bills took a beating during the latest debt ceiling fight in Washington, and it won’t be regained soon, even after the last-minute deal to avert a threatened default.
The temporary agreement to lift the government’s debt limit may only pave the way for another political struggle between President Barack Obama and Republican lawmakers in early 2014 over the federal budget and borrowing levels.
While others measure the toll on the economy from the 16-day federal government shutdown, Wall Street is fretting over the future appetite for U.S. debt and its effect on federal borrowing costs.
Before the shutdown, the Treasury was selling one-month debt at next to nothing. The rise in yields as a result of the crisis will cost the Treasury an estimated $56 million more in interest payments than it would have incurred had this month’s auctions been sold in September.
While some one-month T-bill rates saw their yields decline to 0.02 to 0.03 percent after jumping above 0.70 percent less than 24 hours earlier, bills maturing in February still showed modestly elevated yields. If Washington repeats the battle that ended on Wednesday, bill rates would likely jump again.
“There’s a fundamental change in their risk profile. There’s a growing lack of confidence. It’s going to be problematic,” said Tom Nelson, chief investment officer at Reich & Tang, a New York-based cash management firm that oversees more than $33 billion in assets.
Investors are frustrated that they are forced to shun certain T-bill issues because of the self-imposed fiscal deadlines of politicians. Some of them want additional compensation to buy T-bills given the possibility of default every few months, even though most think the risk is very low.
Chances of a default seemed almost unfathomable three weeks ago before the debt ceiling showdown that accompanied the first partial government shutdown in 17 years.
“The reason you’re holding short Treasuries is because of their unparalleled safety and liquidity. If you’re not getting safety and liquidity, there’s no point in having them,” said Gregory Whiteley, who manages a $53 billion government bond portfolio at DoubleLine Capital in Los Angeles.
Before the political impasse ended, interest rates on T-bill issues set to mature in the second half of October through the first half of November hit five-year highs.
“This is the kind of volatility we have never seen. I’m afraid this will get worse and worse,” Reich’s Nelson said.
The surge in T-bill rates stemmed partly from major money market fund operators, including Fidelity, JPMorgan, BlackRock and PIMCO, dumping their holdings of T-bill issues that mature in the next four weeks because they were seen most vulnerable if the government did not raise the debt ceiling in time.
Reich’s Nelson took more drastic action.
He said he cleared his funds of all T-bills that mature between now and the end of the year and did not jump back to buy them, even after President Obama signed the debt ceiling deal into law before midnight.
In the meantime, default anxiety caused retail investors to rush to redeem their money fund shares.
Money funds posted their biggest weekly outflows in nearly a year, as assets fell $44.77 billion to $2.606 trillion in the week ended October 15, according to iMoneynet’s Money Fund Report.
The asset drop, while large, was still much less than the $103.21 billion plunge in the week ended August 2, 2011 during the first debt ceiling showdown between the White House and top Republican lawmakers.
COST OF A SHORT-TERM DEAL
A pick-up in interest costs, if it persists, would be a setback for the government as its deficit has been shrinking.
“There are costs associated with going through this each time, costs embedded into Treasuries securities, costs the Treasury has to incur in higher risk premiums at auction,” said Rob Toomey, associate general counsel at the Securities Industry and Financial Markets Association (SIFMA), on a call with reporters on Wednesday.
Bidding at last week’s one-month T-bill sale was the weakest since March 2009. Demand at this week’s bill auctions improved on hopes of a debt agreement, but interest rates remained higher than where they were almost three weeks ago.
“This highlights the risk in the United States. It’s not good for investors. If investors want to diversify from the U.S., this gives them a reason to,” said Brian Edmonds, head of rates trading at Cantor Fitzgerald in New York.
Skittishness in owning T-bills hurt Wall Street firms too. The 21 primary dealers, those top-tier investment banks that do business directly with the U.S. Federal Reserve, are required to buy the debt issued by the government at auctions.
“There are too much uncertainties. That’s dangerous especially if you are a primary dealer when you have to underwrite Treasury debt,” said Edmonds.
(Additional reporting by Steve C. Johnson and Karen Brettell; Editing by Leslie Gevirtz)