2
$\begingroup$

The current Fed Funds Rate is 1.75% whereas the 1 Month Treasury Rate is at 1.28%. I would have expected the Fed Funds Rate to be lower than Treasury rate on short maturities, what is the reason of the spread?

$\endgroup$
1
  • 1
    $\begingroup$ There can be some market segmentation e.g. because only banks can access the Fed Funds market, interestingly though the 3m bill rate is close to EFFR. $\endgroup$
    – fes
    Jul 4 at 16:13

2 Answers 2

10
$\begingroup$

There currently is an excess supply of cash looking for short term investments. Money market funds have been receiving a lot of subscriptions. The Feds reverse repo facility has been reaching new records over the last couple of months and has been consistently above $2 Trillion lately. In reverse repo, investors are lending money to the Fed. All the while, there have been no participants in the Fed repo facility.

Also, UST issuance in 4 week bills have been dropping. While several months ago, the US Treasury was auctioning 50B USD a week, the auctions have now been on average 35B USD a week. The reduced supply, with increased demand has caused 4 week bills to trade rich (lower yields) relative to Fed Funds.

$\endgroup$
2
  • $\begingroup$ Nice answer, +1. Do you have an idea if there are e.g. many money market funds that somehow must invest in 1m bills rather than Fed’s reverse repo? $\endgroup$
    – fes
    Jul 5 at 7:54
  • $\begingroup$ @fes I don't know of any. But there are a lot of money market funds. I would imagine that they all have broad mandates to invest in secure short term instruments. I think a requirement to invest in 1M Bills would be too restrictive and they would forego other more attractive returns. $\endgroup$
    – AlRacoon
    Jul 5 at 22:28
2
$\begingroup$

My guess would be this: US treasuries are a "safe-haven" asset where market participants pour money when they fear the stock market will take a dive / other adverse scenarios.

Over the past 4 trading sessions, the US Treasuries have rallied quite significantly (so their yields have lowered): I think that's because today (4th July) is a public holiday in the US so the stock market is closed: the markets are generally risk-averse over holidays, particularly when they fall on a "long weekend" (so people wanted to park their money somewhere safe).

Additionally, there have been fears over the past week that a recession was on the horizon: another reason why the market has become more risk-averse and safe haven assets such as US treasuries have seen increased demand.

On the other hand, the FED funds rate is the rate at which banks borrow from each other: when the market becomes more risk-averse, the rate might actually spike up.

So in conclusion, it is plausible that during market distress, the FED funds rate would be higher than the US treasury yield: although I agree that in "normal" circumstances, the FED funds rate (being an overnight rate) carries "less" of a credit risk than the 1-month borrowing rate of the US government and so should be normally lower.

$\endgroup$

Your Answer

By clicking “Post Your Answer”, you agree to our terms of service, privacy policy and cookie policy

Not the answer you're looking for? Browse other questions tagged or ask your own question.