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The Surreal Market


No playbook for current crisis.

I'll Pay You to Hold My Cash

In the last few weeks, we've seen 30- and 90-day US Treasury bills occasionally trade at a rate of negative interest. That means someone's willing to pay for the privilege of having their cash in US Treasuries. Why would anyone want to do this? Is this a sign the system is broken? Are we that scared?

Not really. There are some explanations for this seemingly bizarre behavior. First, banks are driving the interest rates toward zero. Because their audits come at the end of the year, they want to show a liquid, pristine balance sheet. And what better way to do that than short-term US Treasuries? But that gets us near zero, not below. (And the effective Fed funds rate is at zero, not the posted 1%.)

As David Kotok of Cumberland Advisors noted:

"We cannot find a single investor or institution or organization that would volitionally buy this T-bill at zero interest, let alone a negative yield. We have polled firms and agents and portfolio managers. We've asked people who range from sophisticated, high-net-worth individuals to multi-billion-dollar institutions. None would do it... Foreign currency traders would not do this trade; they have other ways to hedge or structure without buying a negative yield.

"Another possibility is market manipulation or a pricing error. Not this time. All evidence points to the negative yield as seeming to be a market-driven price. This is a real puzzle on the surface."

I've spent more than a little time over the years looking at alternative fund prospectuses and back-room operations, and have been involved in a consulting role for a few funds. Let me tell you how I think interest can get below zero in a perfectly rational market.

Let's say you're trading futures or other leveraged products. You don't need to put up all the money in order to buy a futures contract on oil or the S&P 500. Typically, you simply need a small amount of margin money at the clearing broker, depending on the nature of the contract. Many funds are required by organizational documents to hold cash in short-term Treasuries for liquidity purposes. They have no choice but to buy Treasuries. Some of these funds are quite large; when they come to the market, they come, as we say, "in size."

If you're a trader on the other side of the trade and can make a little extra for scalping such a fund, then you do. It doesn't happen often, but it can (and does) happen when the demand for liquidity is as high as it is today.

I also called my long-time friend, Art Bell, whose eponymous firm, Arthur Bell and Associates, audits a rather large number of commodity and hedge funds. He confirmed at least 1 fund had bought Treasuries at a negative interest rate - not because they were forced to, but because they wanted instantaneous liquidity in case they got margin calls on some of their trades. They didn't want to be forced to sell something at a larger loss than they'd normally take, just because they didn't have the cash. The very small negative interest was the price they willingly paid to avoid larger losses on a trade in a forced sale.

Sounds like smart risk management to me.
No positions in stocks mentioned.

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