T-bill rates

A consequence of the mortgage market blowup. Banks are offering higher rates because many of the are desparate for more money. If they can't get it via bonds or commercial paper, they'll try to get it from retail bank customers. Because if they don't, they may not meet the minimum reserve requirements and have to liquidate holdings at market prices (which would mark their book prices down causing a cascade of decreasing reserves). Meanwhile, investors are fleeing from mortgages and corporate bonds going into Treasuries forcing yields to go down.

Will this continue? My opinion is yes. We're no where near the end of the bad news yet from the mortgage market. As bad as it has been for mortgages, we'll have more resets Q1 2008 than all of this year. It will be a total bloodbath.

Looking at Schwab's brokered CD offering, I see 6mo at 5.33%, 1yr at

5.15%. The yield falls going further out (to below 5%). It would stand to reason that a 1 yr t-bill will be close to a one year CD, adjusting a bit for the difference in state tax. (yes, there is a minor liquidity issue with the CDs, which for 1 year or less I find irrelevant) I am shifting new money to the CDs from T-bill coming due. Keep in mind the $100K FDIC limit, discussed here ad nauseum recently. JOE

That's the explanation my Schwab broker gave me. But I still do not fully understand. That is, I would understand that theory for normal bonds. Why offer a high yield when people are willing to buy even at a lower yield? But I did not think that the rates on T-bills and T- notes were set by market demand. I thought their rates were set by a formula based on some Federal Reserve rate.

The price is set at auction. Thus the yield reflect market demand. For a longer term note with a coupon (i.e. an interest payment) the treasury has to decide what coupon they will offer. If they are about to sell five year notes, they can see what the market rate is for that point on the yield curve and set the coupon accordingly, to have a goal of 100 for the auction price. A price above or below would result in a YTM (yield to maturity) higher or lower than originally targeted. JOE

Nope, new Treasury issues go out via auction.

Agree with that part.

Disagree. Mortgage demand is still high despite slowdown. However non-bank source of money have all but dried up. Banks are borrowing to Fed, paying high interest, etc. to satisfy mortgage demand

I have always been able to find bank CDs which pay more than T-Bills - even after considering that T Bill interest is not taxable by states a factor in CA and elsewhere

My reasons for the CD premium is that a) CDs are not as liquid as T-Bills b) Accrued interest is taxable annually even though you didn't get it in your pocket c) if the issuing bank fails, the FDIC can "call" your CD before it is due

Interesting ideas, but like most thoughts, have more than one side:

Liquidity doesn't exist in a vacuum. Almost anything is immediately liquid if you're willing to take enough of a loss on it. CDs under 1 year (to be comparable with T-Bills) are typically redeemable with 1-3 months loss of interest. T-bills, on the other hand, have to be sold on the open market, with its accompanying price uncertainty and its transaction costs.

(asserts 1-3 month penalties common)

Again, since we're talking about T-bills, we're talking about CDs under a year. For those CDs, one can defer interest until the CD matures - you don't get it in your pocket, and it isn't taxable until you do. And unlike T-bills, you often have a choice of whether to get the interest in hand, or have it compound within the CD.

Also an interesting thought. Mitigated by the fact that we are talking about short term instruments, but the advantage here goes to the T-bill.

There are other factors that one could imagine, but I don't know which (if any) explains the phenomenon. Treasuries may be sold at auction, but are bid on primarily by large investors who might not be using a bank with its "mere" $100K insurance. There is a psychological factor of people thinking that Treasuries are more secure (as sound as the dollar - wait, let me rephrase that :-).

There is a single market rate for T-bills (of a given maturity) at any time, while CD rates vary. The average CD rate could still comparable to the T-bill rate (often the promotion rates you see are for new money only). According to Bloomberg, 6 month T-bill yield is 4.21%. According to bankrate.com, the average 6 month CD rate is 4.58%, similar once one considers state taxes.

Mark Freeland snipped-for-privacy@sbcglobal.net

I can't prove it but I think that the 1-3 mo penalty may be larger than the transaction costs if large amounts are involved

The quoted rates assume compounding. Buy a 6 mo CD in November and you will pay taxes before you get the compounded interest back.

My recollection of the S&L crisis was that the FDIC (the S&Ls had a different agency) or the successor institution often "called" the CD's as of the S&L's failure.

As you point out, buyer's perception may be part of the reason. Note that in most cases it is not your neighborhood bank or the large banks which offer the high rates

Not if you buy a less-than-one-year CD that pays all its interest at maturity at the quoted APY rate. And they do exist (usually found through brokers, though).

-- Rich Carreiro snipped-for-privacy@rlcarr.com

Same is true for all the marketable treasury securities. The exception is treasury savings bonds (ie. series I and EE), but they aren't marketable. They may be cashed in like a CD, sometimes with a penalty, but unlike marketable securities, if interest rates go down, they don't go up in value in the secondary (since it doesn't exist) market.

The annual taxation of the not-in-your-pocket inflation adjustments of TIPS is one of the reasons one ought normally not own them in taxable accounts.

If the Fed takes action today, you may see T-bill rates normalize with respect to other money market instruments, including CDs, CP, BAs, etc. For now, certain CDs are providing a higher return than T- bills. Spread your money around to different banks, either via a brokered CD progam mentioned above, the internet (make sure of the FDIC insurance, or on your own. Different markets have different rates. For example, Chase is offering a 7 month CD with a 5.45% yield in the New York area, but not nationally.

I think you hit at the heart of the matter, as did Mark above. The treasury rate is, for lack of a better term, the national average for T-bills. The CDs that they are being compared to most likely are not. They're outliers, so to speak. For every 5.45% CD there's probably a

4% one too. I saw a local bank offering 3.85% just yesterday. On that alone should I start an inverse thread of this one?

The microeconomies of local regions, the unknown business models of specific banks, variances in state taxation, etc, etc, will all affect the rate at a particular bank. As Mark sposted above, if we choose to trust bankrate's average then T-bills have NOT dropped below cd rates ON AVERAGE once taxes are taken into account.