The yield on a 90-day Treasury bill closed at 0.005% on Friday, November 20. Yep, some investors were willing to lock up their money for three months and get an exciting five-hundredths of a percent in interest.
But that’s not the most shocking thing that happened on the Treasury market last week. On some Treasury bills, those due to mature in January, the interest rate actually dropped below zero.
Now you can say that a yield of 0.005% means that investors are anticipating deflation or that they are so anxious to buy the security of the world’s most liquid financial market that they’ll pay anything.
But the negative yields for Treasury bills that mature in January suggest that something else is going on.
And that something else is end-of-the-year window dressing by banks and other financial institutions that want to make their balance sheets look as solid and conservative as possible. Nothing is less risky, after all, than a short-term U.S. Treasury bill.
Now why would banks want to make their end of the year balance sheets look good? Regulators are looking at banks especially carefully over the next few months to see which banks need to raise capital and how much. Banks don t especially want to have to raise capital right now: It’s expensive and once you’ve raised it, it will just sit in the vault depressing all those ratios that bank analysts use to figure out what bank stocks to recommend.
Much better to reduce the amount of capital a bank might have to raise by showing that its capital is invested in the safest and most highly rated vehicles. (Regulators use complicated formulas to calculate how much capital a bank should have on hand. The formulas consider not just how much capital a bank has but how risky that capital is. In general banks need to have less capital if that capital is in safe, low-risk vehicles.)
You could file this away as just another bit of bank accounting slight-of-hand except that this end of the year Treasury buying reduces the amount of cash that’s available to go into other assets. Money that’s going into Treasuries is money that isn’t going into corporate bonds or asset-backed securities or commodities or equities.
I don’t know of any way to quantify how much of a shift in cash flows this end of the year buying of Treasuries might represent. It’s impossible to say what this money would be flowing into if it wasn’t flowing into Treasuries.
But to the extent that it represents an end of the year trend away from risk and toward safe assets it is a negative for commodities and stocks.
Already in the last few trading sessions there have been signs of end of the year profit taking by investment managers who figure that they’ve performed well enough in 2009 versus their peers and the indexes that they don’t want to risk a setback in the last month of the year.
Add this window-dressing to the picture and the cash flow picture gets even more complicated and harder to read.
Which wouldn’t be as big a problem if the odds that December will continue the rally that began in March weren’t so utterly dependent on the size and direction of cash flows.
And it does raise the possibility that January—when financial institutions start to unwind these safe positions—could be a very interesting month indeed.