Money-Fund Slowdown Pushes Up Short-Term Treasury Yields

A significant slowdown in cash inflows to money-market funds this year is impacting short-term Treasury yields, raising concerns about potential funding challenges. Data from TD Securities shows that inflows have totaled just $158 billion in the first three quarters of 2023, a sharp decline from $823 billion in 2022 and $840 billion in 2021. This reduced demand has pushed up yields on Treasury bills, with analysts noting that investors now require a larger premium to hold them.

The softening demand is reflected in the relative pricing of Treasury bills. On Monday, US 3-month bill yields rose nearly 10 basis points above the 3-month overnight index swaps (OIS), hitting the widest spread since September 2022. For 6-month maturities, the spread reached 11.3 basis points, the highest since April 2023. Analysts attribute this to expectations of heavy Treasury supply in the fourth quarter and further interest rate hikes by the Federal Reserve.

Sam Earl, a US rates strategist at Barclays, noted that money-market funds are faced with the challenge of deciding where to allocate their assets in the absence of strong inflows. Despite the slowdown, money-market funds remain net buyers of Treasury bills, though demand has slowed markedly. By the end of August, their holdings had increased roughly 4% from year-end 2022, compared to an 18% rise over all of 2022.

The rise in Treasury bill yields also reflects growing uncertainty over interest rate directions. US rate futures have priced in one rate hike of 25 basis points this year, and two more in 2024, according to LSEG estimates. Money fund managers are shortening portfolio maturities in anticipation of higher interest rates, allowing them to reinvest at higher yields if the Fed raises rates. The weighted average maturity (WAM) of money funds has declined to 36 days last month from a peak of 42 days in May.

Analysts caution that higher yields, if they persist, could alter cash flows across short-term funding markets. If money funds shift cash from overnight repo markets to higher-yielding Treasury bills, funding conditions could tighten, pushing up repo rates and raising financing costs. However, it is too early to sound the alarm, as money fund inflows typically accelerate in the fourth quarter ahead of year-end liquidity needs and tax payments.

Gennadiy Goldberg, head of US rates strategy at TD Securities, highlighted that the Treasury's focus on issuing more bills is concerning given the slowdown in demand. Vanguard’s Nafis Smith noted that the strength of the US equity market this year has reduced the investor impulse to put money into cash, with the S&P 500 up 13% and the Nasdaq up 18% so far this year.