Why Stock Investors Should Fear Collapsing Treasury Bill Yields

 

With year-end 2009 approaching, a perplexing mystery has begun unfolding in the market for short-term U.S. Treasury securities. Much like the case in 2008 when risk of the global financial system’s collapse was elevated, demand for Treasury Bills has increased to the point of dropping yields into the negative in some cases. Hard to believe debt issued by the U.S. government — already in hock to the tune of $11 trillion — could be so great that, investors would be willing to pay interest in exchange for the promise of repayment of principle some months forward (T-bills go out to durations of up to one year). What is going on?

Although it may be impossible to say with absolute certainty, CNBC’s Rick Santelli on Thursday, November 19, 2009 — following a contentious appearance by Treasury Secretary Tim Geithner before the Congressional Joint Economic Committee — suggested heightened demand for T-Bills might be a consequence of waning confidence in the Obama Administration’s economic team. Given the wanton desire of Treasury and Federal Reserve policymakers to flood the global credit system with more liquidity than at any time since Noah, any challenge to this power might be perceived a threat to some crucial part of the global credit system, thus precipitating the recent rush into the safest of safe financial securities: U.S. Treasury Bills.

Then, too, PIMCO’s Bill Gross in his November 2009 musing titled, “Midnight Candles,” confessed that credit risk these days simply is too great to make low yields offered by below-investment-grade securities attractive. In other words, Mr. Gross — no small influence in the bond world — said stay away, or worse, get out. Trouble is without increasing capital flows into below-investment-grade securities there is an elevated risk some segment of these securities will collapse. Given this risk, then, the rush into Treasury Bills might make sense.

Finally, an increasing drumbeat among Asian authorities calling for capital controls restricting entry of so-called “hot money” into various Asian economies threatens to shrink available destinations for dollar liquidity being created these days as though there might be no tomorrow. This could be another reason why capital suddenly is rushing into short-term Treasuries. Absent overseas destinations for making investments deemed safe and attractive, Treasury Bills apparently are seen the next best thing.

Bottom line is anything threatening massive efforts over the past year to keep the global financial system afloat increases risk in those [many] financial assets on the periphery. Mitigating risk on the periphery of the global credit system is the very reason all the liquidity-creating facilities implemented over the past year have come into being. Should this effort fail, then much like we saw in 2008 a spill-over effect hitting equities could result. Failure to keep capital flowing into every variety of credit security under the sun (remember sub-prime?) invariably will result in systemic stress leading to liquidation of financial assets in well-developed markets where capital quickly can be raised. This is why anyone with an interest in the stock market these days ought pay attention to the recent rush of capital into U.S. Treasury Bills. It suggests something, somewhere, is wrong.

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