Time for Treasurers to Sell Short-Term U.S. Debt?
Although the cost to insure against a U.S. government debt default is rising and short-term Treasury yields are climbing, asset managers are counseling CFOs and treasurers to avoid selling off short-term Treasury notes that they hold in cash investment portfolios.
A failure of the U.S. Congress to raise the limit on federal government borrowing by October 17 could cause the Treasury Department to miss interest payments on short-term notes, which are theoretically “risk free” assets.
But Lance Pan, director of investment research at Capital Advisors Group, said treasurers and CFOs need not panic. Instead, companies that directly hold Treasury bills or are invested in money market funds that hold them should take a wait-and-see stance. “We’re not advising treasurers to sell into the down market, because yields have already gone up,” he told CFO. “In the unlikely event Treasury misses a payment you are still going to be paid, just not on the day promised.”
On Thursday, Republican leaders in the House of Representatives and the White House began talking about a tentative agreement that would extend U.S. borrowings for six weeks. But any deal would have to go through both houses of Congress and could get weighed down by legislators trying to attach conditions to it.
In the meantime, however, money market funds like those managed by Fidelity Investments are trimming or eliminating their holdings of Treasuries, especially those that mature between October 17 and November 15. The yield on the one-month T-bill climbed to 3 basis points earlier this week before falling back to 2.5 basis points on Thursday. In comparison, the three-month bill was yielding less than half a basis point.
Pan says Capital Advisors Group is not selling any of its short-term Treasury holdings. At the same time, it is not adding to its short positions. “Not because of credit issues,” Pan explained, “but because we don’t want to make our clients nervous by adding something perceived to be at risk of a delayed payment.” Capital Advisors provides separately managed accounts to companies, many of which have a mandate to invest in Treasury and government-agency securities.
In addition, “because of what Fidelity has done, we are paying more attention to commingled vehicles like money-market funds to see if there is a follow-on effect,” Pan says.
Importantly, most companies access the U.S. Treasury market through funds that comply with the Securities and Exchange Commission’s 2a-7 rules, and thus should be “well positioned to ride out the brinkmanship in Washington,” says Jeff Jellison, CEO of ICD, which provides analytics and trading tools for treasury departments.
Money-market funds carry a stable net asset value and thus don’t have to account for gains and losses on a daily basis. More importantly, 2a-7 funds are not required to sell a security that is in default unless its board of directors decides to. That would prevent any of them from “breaking the buck” — having the value of their shares fall below $1, and avoiding a loss for shareholders. A recent study by the Federal Reserve Bank of New York found that 28 money-market funds, more than previously thought, had large-enough losses to break the buck during the financial crisis.
The credit-rating agencies are split on whether or not a missed Treasury payment would be a technical default. Moody’s Investors Service has stated in the short term it expects the United States’ credit rating to remain intact, even if Congress doesn’t meet the October 17 deadline to raise the debt ceiling. If the United States misses an interest payment or two to holders of Treasury securities, a downgrade might only be temporary. (The first interest payment due from Treasury would be October 31, in the amount of $6 billion.)
In any case, the money market funds that hold large portfolios of such Treasuries are unlikely to receive downgrades from the rating agencies, Pan says.
Any selective default on short-term Treasuries will be short, says Pan. “Once you have a missed payment that becomes an ‘all-hands-on-deck’ situation for Congress, Treasury and the White House,” he says. “The situation would be remedied within hours, not days.”
The unknown, of course, is how the financial markets would react to a missed payment on Treasuries, which Pan says is impossible to gauge. Although money market funds have stable NAVs, for example, many now post their marked-to-market NAVs online. If yields on short-term Treasuries continue to rise, a fund with large Treasury bill holdings might have losses large enough to affect its market, or “shadow,” NAV. Such a situation could spook investors and cause a run on shares of some money-market funds.