Thursday, November 19, 2009
Yields on 3-mo. T-bills have gone to zero, once again. The last time this happened was in December of last year. At that time, the world was in full panic mode, with markets braced for a double-deep depression and years of deflation. The stock market was about 20% lower than it is today, credit and swap spreads were on the moon, the Vix index was almost double what it is today, and 10-yr Treasury yields were approaching 2%.
So now that the signs of panic have receded hugely, why are bill yields again approaching zero? It could be year-end pressures, as portfolio managers unwind risky positions and build up cash so their year-end statements reflect some prudence. Or it could be that, as I've mentioned in recent posts on TIPS, the market is capitulating to the idea that the Fed is going to keep the funds rate near zero all throughout the coming year. Alternatively, it could be that the prospect of the Fed being on hold for a prolonged period is awakening inflation expectations; if you're a bond manager afraid that bond yields may be rising in the future, you'll want to sell bonds and park the money in cash and TIPS. The facts seem to support this last explanation best, since the yield curve is unusually steep and breakeven inflation expectations have risen meaningfully as bill yields have collapsed.
So I'm tempted to say that the best explanation for why bills are trading near zero is that the bond market is feeling very uncomfortable with the idea of one more year of zero rates from the Fed. I sympathize with that feeling, since I find it very hard to believe that the Fed will actually deliver on its promise to keep rates at zero for a very long time. I see too many positive developments in the economy on the margin, and I see too many signs of rising inflation pressures on the margin. I think the Fed could and should raise rates much sooner than most people suspect.
In any event, bill yields approaching zero are one way the market has of telling you to watch out for surprises that could be lurking behind the next corner.
Posted by Scott Grannis at 2:03 PM