Fixed income perspective – from the Investment Advisory Group

1-month/3-month yield differential is largest on record

• Absent raising the debt ceiling, the U.S. is expected to meet its legal debt limit sometime between June and September (often referred to as the “X date”), depending on the amount of federal tax receipts collected this year.
• As a result, many investors are avoiding U.S. Treasury bills (T-bills) maturing within the summer months and are instead purchasing 1-month T-bills that are expected to mature before the X date is ultimately reached.
• The surge in demand has driven the 1-month T-bill yield down from 4.83% on March 10 to 3.37%, as of this writing. Meanwhile, elevated 3- to 6-month T-bill yields have barely budged, focusing on hawkish Fed policy expectations and angst over whether Congress will hammer out a timely debt agreement.
• 1-year credit default swaps on U.S. Treasury bonds, which provide investors insurance in the event of a U.S. default over the next 12 months, are at their most expensive levels on record. In other words, concerns over timely U.S. government debt payments are at an all-time high.
• The plummeting 1-month yield and elevated 3-month yield have created their largest divergence on record (see chart). 3-month yields are flirting with their highest levels since 2007. Volatility in this portion of the curve will remain high as the X date approaches and traders speculate over the Fed’s future rate path.
• We believe Congress raising the debt ceiling ahead of the X date (after heated partisan disagreement and with little time to spare) is the most likely outcome. In the event the deadline passes without an agreement, we expect U.S. bondholders to eventually receive their full principal and interest owed. However, the unprecedented delay would create significant market and investor disruption.
• From a purely income perspective, U.S. government yields between 2- and 12-month maturities remain very compelling. Once a debt agreement is reached, yields in this region of the curve are likely to fall as uncertainty is removed. By that time, we believe the Fed is likely to have completed its rate hike cycle. That suggests short-dated yields will continue to trend lower over the next 18 months.
• Investors in T-bills maturing within the next six months should be prepared to endure elevated volatility, headline risk, and unease over partisan brinksmanship tactics. There is a slight risk of late payment, though we expect U.S. bondholders to be made whole.  

To read the publication in its entirety, including charts and support, please select the "Download PDF" button, below.