Supply-Starved Bill Traders Are Looking to Fed Minutes for Salve

(Bloomberg) -- Traders in Treasury bills will be closely watching minutes from the Federal Reserve last meeting for clues on the plan to unwind its $9 trillion balance sheet that could signal an easing in the supply imbalance.

Fed Chair Jerome Powell said last month details on the mechanics for the so-called quantitative tightening, or QT, will likely be revealed in the minutes. That has set the stage for the market to look at how the Fed will treat its portfolio of Treasury bills at a time when a scarcity of short-end paper commands a premium. Meanwhile, expectations are largely baked in that the monetary authority will announce the beginning of the unwind as early as next month, with coupon holdings likely subjected to a reinvestment cap used in the last round of QT that started in 2017.

While T-bills yield have been rising with the rest of the complex as further rate hikes get priced on hawkish Fed comments, they have fallen relative to overnight index swaps, which measure traders' bets on central bank rates. In fact, the gap between three-month bill yields and OIS last week reached the widest level in more than five years. Should the Fed decide to let its $326 billion of T-bills merely run off and to replace that with new debt, the influx could help reverse the trend.

The keen interest on the Fed's bill holdings is due to the fact that the last time the central bank unwound its balance sheet it didn't own any of the securities. It's also critical for money-market traders that have been struggling to find assets in which to invest, largely opting to park excess cash at the reverse repurchase agreement facility.

“The easiest way to initiate QT is to let those Treasury bills mature and they can do it organically,” said Peter Yi, director of short-duration fixed income and head of credit research at Northern Trust Asset Management, which oversaw $1.3 trillion as of the end of 2021. “The money-market sector could certainly use more Treasury bills because of the paydowns.”

Total assets in government money-market funds are around $4.08 trillion, Investment Company Institute data show. Then there's about $1.7 trillion in excess cash parked at the Fed's RRP facility on a daily basis. At the same time, the Treasury paid down about $126 billion of bills in March ahead of the April deadline for U.S. tax receipts, according to Treasury data. Strategists estimate additional paydowns in the second quarter could total $300 billion, further adding to the scarcity.

“Markets could absorb even the full $326 billion of additional bill supply in just a few months without breaking a sweat,” RBC strategist Blake Gwinn wrote in a note to clients. “If anything, any cheapening of bill yields (relative to OIS) could be underwhelming given just how out of balance front-end supply and demand currently are.”