Liquidity lowdown: T-bill interest surges

Demand for UK Treasury Bills (T-bills) has surged in recent weeks and we believe there is scope for further growth in demand ahead. Money Market Funds (MMFs) are typically large holders of T-bills and make up an increasingly large proportion of the investor base. With potential regulatory amendments looming which would require MMFs to hold additional increased liquidity, demand is only likely to go one way. But despite MMFs being the largest buyer there are other market participants keen to enter the market given that the yields on offer are attractive. Lack of opportunities elsewhere in an uncertain market environment has ramped up demand for short-dated government debt.

Expectations for rate cuts have, in recent weeks shifted forwards following stronger-than-expected Consumer Price Index (CPI) inflation data in the UK, with services inflation remaining uncomfortably high at 5.9%, having only fallen by 0.1% from the previous month. This has undoubtedly contributed to investors being drawn more towards six-month T-bills, with less demand being seen in one-month T-bills. 31 May 2024 saw the second lowest level of demand in one-month T-bills since the start of the year, and the highest yield on six-months bills with an average yield of 5.24%. Extending duration at these levels has made a lot of sense to many investors.

But with increased demand has also come increased Issuance, which has persisted since the start of the year. So far, each month has seen an additional £0.5 billion of six-month T-bills coming to market in the weekly auction, which has amounted to an increase of 57.1% since the start of the year. June month will prove no exception as issuance increases from £3 billion to £3.5 billion in the first week of the month. So given the increase in both supply and demand, the bid to cover ratio – the amount of bids received in an auction versus the amount sold – has remained reasonably constant. This has to some degree prevented T-bills from becoming increasingly more expensive, as market participants come to auction to look for liquidity and yield in short-dated government debt.

The increased attraction to T-bills at auction, however, has meant there has been some slowdown in the secondary market, which usually comes to life in the aftermath of the weekly auction. Yields on secondary T-bills have been increasingly converging to those offered on primary issues, meaning they are cheaper than they once were. Nonetheless, we find most buyers will naturally head to auction with activity on the secondary market in May being rather subdued. The secondary market has never been as active as in gilts for example, but we still find T-Bills highly liquid should they need to be sold, although many MMFs will often hold them to maturity. They offer a natural hedge against any credit risk in the Fund, which can balance out any potential mark-to market losses from a credit stress event. We believe any additional issuance of T-bills can easily be absorbed by the market.

Certificates of deposits (CDs) have ended May at similar levels to where they started, with one-year CDs achieving yields close to 5.35%. The spread of T-bills to CDs has widened during May 2024, because CDs are starting to offer higher yields and are becoming more attractive to investors again after a slow start to the year. Issuers have begun to regain some appetite for longer term funding, and we see this trend continuing.

This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.