The US$1.5 trillion market for U.S. Treasury bills, known as an oasis of stability for investors worldwide, is experiencing the most volatility since the financial crisis.
Daily swings in the government's shortest-maturity obligations are widening as debate over the Federal Reserve's path collides with rising demand for the securities before the implementation of regulations intended to make money-market funds safer.
The gyrations underscore how it's a precarious time for investors in bills and other instruments in the money market, which the Fed uses to implement policy changes. Asset managers looking to park cash in the short-term securities have to navigate officials' efforts to normalize interest rates while also adapting to post-crisis rules.
Skepticism toward the Fed's plans to boost its overnight target, following liftoff from near zero in December, is fueling the volatility. Futures assign a 2 per cent chance of an increase at officials' June 14-15 gathering, and the probability doesn't exceed a coin toss until December.
“The Fed has hiked once already, so we are in a tightening cycle, but there is enough uncertainty about what that will look like,” said William Marshall, an interest-rate strategist in New York at Credit Suisse Group AG, one of the Fed's 23 primary dealers. “The other big uncertainty, where there is still a lot of debate, is what is going to be the end state for front-end demand once the money-fund reforms go into effect.”
The daily gap between the one-month bill's lowest and highest rates in 2016 has averaged 0.04 per centage point through June 3, according to data compiled by Bloomberg. While that may not seem like much, it's the most intraday movement for the comparable period since 2008, and wider than in the five-month span leading up to the December liftoff.
In March, policy makers projected two hikes this year, and they'll update that forecast next week. Fed Chair Janet Yellen on Monday called additional gradual rate increases appropriate, without specifying timing. She said weaker-than-forecast May jobs data were “disappointing,” while cautioning against giving too much significance to one monthly report.
“This is going to be one of those where the market prices in one hike at a time,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA, another primary dealer. “That adds to volatility in the front end, which is what you see in the bill complex.”
The pickup in fluctuations for one-month bills, which yielded about 0.17 per cent Monday, still leaves volatility far short of what it was during the financial crisis. The average daily swing in 2008 was 0.17 percentage point for the maturity, at a time when the Fed was slashing rates to support the economy.
This year, the adoption of new regulations is at play as well.
On Oct. 14, Securities and Exchange Commission rules take effect that may lead investors to shift into money-market funds focused on government debt, from prime funds, which typically buy commercial paper. The new regulations mandate that institutional prime funds report prices that fluctuate, rather than sticking to US$1 per share. The measures also allow fund companies to use steps such as redemption fees to prevent runs in times of panic.
Amid all the changes, which have already led many money- market companies to alter their offerings, institutional investors may pull about US$400 billion from prime funds, JPMorgan Chase & Co. predicted in the first quarter.
The combination of fluctuating Fed bets and purchases of bills related to regulatory changes will spur volatility, said Jerome Schneider, head of short-term portfolio management at Newport Beach, California-based Pacific Investment Management Co., which oversees US$1.5 trillion.
“Until these stimuli become reconciled and resolved, we may continue to see relative repricing a normal event in this sector,” he said.