(Bloomberg) -- These days, investors are so worried about the short-term outlook for the economy that they’re willing to pay the U.S. to hold their money -- if only the government would allow it.
Since the Federal Reserve slashed interest rates and introduced a raft of emergency measures two weeks ago to combat the economic fallout of the coronavirus pandemic, four-week T-bills have consistently traded at rates below 0% in the open market. But, unlike other governments such as Germany or Switzerland, existing rules prevent the U.S. Treasury from actually issuing debt with negative yields at auction.
The conundrum has the potential to cost U.S. taxpayers billions of dollars if rates stay lower for longer, particularly as the U.S. is poised to issue more debt after the Senate passed a $2 trillion rescue package this week. For example, on Thursday, the Treasury sold $60 billion of four-week bills at the minimum allowed rate of 0%. But because the current market rate is roughly -0.14%, dealers can turn around and sell those bills at a premium and pocket an immediate windfall. In this case, about $7 million. That might not sound like much, with over $2.5 trillion of bills outstanding, it can add up very quickly.
“The Treasury absolutely, categorically, right now has to be thinking about this,” said Seth Carpenter, an economist at UBS, and a former Treasury official and adviser to the Fed. In the current situation, “you are essentially just transferring wealth to other people. The Treasury is in a bind and they have to make a decision on this with bill rates being negative as they are.”
The systems are already in place. In 2015, when bills also traded at persistently negative levels amid supply cuts to keep the U.S. under its statutory debt limit, Treasury adjusted its systems to allow it to handle a negative auction rate, according to former Treasury officials familiar with the matter. However, it never followed through and changed its policy.
A Treasury spokesman did not reply to a request for comment.
In addition to the four-week bill auction, Treasury sold $50 billion of eight-week bills on Thursday at an auction rate of 0%. In the open market, eight-week bills trade at -0.1%. (A quick refresher: T-bills don’t actually pay a coupon, but are instead sold at a discount to par, which reflects the effective interest rate on the security. At 0%, the price would be 100 cents on the dollar. If the Treasury allowed negative-rate bidding, the securities would be sold at a premium.)
One reason the government might not want to allow negative-rate bidding is that it risks signaling to investors that negative rates are here to stay, according to former Treasury officials and staffers.
It might also be politically fraught. The Fed has made clear it doesn’t see negative rates as a viable policy tool. For his part, President Donald Trump, has pushed the Fed to follow the European Central Bank and cut its benchmark rate to below zero.
“It’s a political hot potato,” said Ward McCarthy, chief financial economist at Jefferies and a former senior economist at the Richmond Fed. And “philosophically, I am just opposed to investors paying the U.S. government to hold their debt. Especially since small investors tend to be especially involved in the Treasury bill market.”
It’s not the first time the issue of negative-rate auctions has come up. In August 2012, in a statement presented at its quarterly debt-refunding operation, the Treasury’s then-assistant secretary for financial markets said the government was “in the process of building the operational capabilities to allow for negative-rate bidding in Treasury bill auctions, should we make the determination to allow such bidding in the future.”
Yet even with bill demand as high as it’s been, competing priorities could keep the Treasury from pulling the trigger, at least for now.
“Selling bills at negative yields would benefit the taxpayers, but would put the Treasury at odds with the Fed, which hasn’t sanctioned negative rates,” said Mary Miller, the Treasury’s former undersecretary for domestic finance in the Obama administration, who’s running for mayor of Baltimore. The current situation “may just be a temporary disruption, so it’s worth watching to see if this rights itself with the big economic rescue steps.”
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