The 3mo T-bill or the "Cash under the mattress" strategy

by Rod Gonzalez

Treasury prices dropped Wednesday as investors profited from the recent rally that have pushed government debt to levels not seen in decades. Although equities spent part of the afternoon trading in the red, the end of the day saw the Dow Jones up 70 points to close at 8,761 points. The 5-year note lost 2/32s to yield 1.61%; the 10-year benchmark dropped 13/32s to yield 2.68% while the long bond lost 1 point to yield 3.08%. Although government debt dropped in value yesterday, the recent trend has been a strong demand for paper across all maturities. In fact and as an example, the price of the long bond has increased by 21% in the past month as the major industrialized countries continue to struggle amid weakening economies and rising unemployment. This has pushed oil demand to 5-year lows (down 100 dollars from its record high in the summer) as a lack of economic growth means less demand for fuel; and consequently inflationary expectations have come down with oil. Perhaps more interesting is what is happening to the short maturities (not as affected by inflation) where maturities under 2 years are trading below 1.00%.

The graph below shows the historical relationship between the Fed Funds and the 3-Mo T-bill where it can be seen that the market typically acts quicker than the Fed in predicting short term yields (as investors act ahead of future FOMC actions). The graph is titled 3-Mo T-bill versus Fed Funds or the putting the “cash under the mattress” strategy as investors’ recent demand for T-bills have pushed yields to practically 0.00% (see second part of the graph). In fact, the 3-Mo T-bill traded at negative levels for some part of Tuesday as investors’ concern of a severe economic slowdown push them to seek what is considered the safest (and one of the shortest) possible investment. The recent economic slowdown has reversed inflationary expectations so drastically that the risk of “deflation” also plays a part in the recent levels seen in T-bills.

Treasury prices have bounced back from yesterday’s losses as today’s economic releases continue to exhibit the Lower Inflation/Weaker Labor Market trend. The 5-year note has gained 9/32s to yield 1.55% while the 10-year benchmark is 14/32s higher at 2.63% and the long bond has recovered 23/32s to yield 3.05%. For the record, the Bureau of Labor Statistics of the U.S. Department of Labor reported today that the U.S. Import Price Index decreased 6.70% in November, its largest drop since the index was created. The annual change was -4.40% versus the expected -2.00%. The decrease in prices was led by a 25.8% YoY drop in oil prices. Additionally, the Commerce Department announced that the Trade Deficit increased slightly for the month of October (first time since July) to -$57.19B versus analysts’ consensus of -$52.8B. This increase in the imports/exports trade gap can be attributed to a significant increase in amount of “cheap” oil imported offsetting the lower price per barrel as well as a drop in car purchases. Additionally, U.S. exports declined 2.20% to $151.73 billion as other economies also slowed down, affecting sales of U.S. good and services.

Finally, the Department of Labor released its weekly Initial Jobless Claims report in which claims rose in the previous week to 573,000 versus the expected 525,000. Continuing claims also increased by 338,000 to 4.43 million. The less volatile 4-week average number of initial claims was also consistent with this upward trend in unemployment by reporting an increase of 14,250 from the reported 526,250 for the previous week.