 Ask
Dr. Econ
December 2000
What makes Treasury bill rates rise and fall? What effect does the
economy have on T-Bill rates?
Treasury bills
Investors consider U.S. Treasury bills (T-bills) to be the safest short-term
financial instrument because these debt obligations are perceived to have
no default risk. Moreover, because T-bills mature in less than one year--most
mature in several months--they do not have a large interest rate risk
component, either.
The large and liquid Treasury bill market plays an important role in
the financial system. The December 2000 Federal Reserve Bulletin
reported $616.2 billion in Treasury bills were outstanding at the end
of the third quarter of 2000.
T-bills are liquid; there is an active secondary market where they may
be traded. They are important financial instruments to individuals, financial
institutions, corporations, governments and the Federal Reserve System,
all of which hold sizeable amounts of U.S. Treasury debt, including T-bills,
in their portfolios.
T-bill Auctions
The U.S. Treasury sells 3-month and 6-month Treasury bills at weekly
competitive auctions.
The auctions
(see http://www.publicdebt.treas.gov/sec/sec.htm)
take place as part of the Treasury's effort to manage the federal debt.
The prices for new T-bills (and yields—see Appendix) are determined
by supply and demand conditions at each auction. The prices and yields
for existing T-bills are determined in the secondary market.
What Moves Treasury Bill Interest Rates Up and Down?
Many factors may affect Treasury bill interest rates in general, as well
as rates for specific issues of Treasury securities, in particular. Here
are several factors you might want to consider:
- Demand for risk-free fixed-income securities in general—For
example, a "flight to safety" caused by concerns about default
or liquidity risk in other financial markets may cause investors to
shift to T-bills to avoid risk.
- Supply of T-bills by the U.S. government--for example, federal
budget surpluses in 1998-2000 have reduced the supply of some Treasury
securities issues.
- Economic conditions may influence rates--for example, Rose
(1994) notes that T-bill rates typically rise during periods
of business expansion and fall during recessions.
- Monetary policy actions by the Federal Reserve--Fed actions
that affect the Federal funds rate likely will influence interest
rates for other close substitutes, including short-term T-bills.
- Inflation and inflation expectations also are factors in
determining interest rates--for example, periods of relatively high
(low) rates of inflation usually are associated with relatively high
(low) interest rates on T-bills (see chart, below).
APPENDIX: Calculating Yields on Treasury Bills for
Comparison Purposes
Treasury bills are sold at a discount. The difference between the auction
sales price and the value of the T-bill at maturity represents the income
from the T-bill. Yields on T-bills are calculated using the bank discount
method, as shown below:
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Discount Rate =
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Par Value - Purchase Price
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x
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_______360 days______
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|
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Par Value
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Number of days to maturity
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Because the bank discount method does not account for compounding of
interest or the actual number of days in a year (365 or 366), the calculated
T-bill discount rate always is lower than the investment yield on a T-bill.
You may account for this understatement of the return by converting the
discount rate to an investment yield (or coupon-equivalent yield). After
making that conversion you may make comparisons with yields on other types
of instruments. The following formula converts a discount rate to an investment
yield:
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Investment Yield =
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_________365 x Discount Rate______
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360 - (Discount Rate x Days to maturity)
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Endnotes:
References:
Dupont, Dominique, and Brian Sack. 1999. "The Treasury Securities
Market: Overview and Recent Developments." Federal Reserve Bulletin,
Board of Governors of the Federal Reserve System, December, pages 785-806.
http://www.federalreserve.gov/pubs/bulletin/1999/99index.htm
Federal Reserve Bulletin, 2000. Board of Governors of the Federal
Reserve System, December, Statistical Table 1.41, page A27, Gross Public
Debt of U.S. Treasury.
Federal Reserve Statistical Release, H.4.1. "Factors Affecting
Reserve Balances." Board of Governors of the Federal Reserve System,
December 28, 2000.
http://www.federalreserve.gov/releases/H41/
Meulendyke, Ann-Marie. 1998. U.S. Monetary Policy and Financial Markets.
Federal Reserve Bank of New York, New York. See Chapter 4, Financial Markets,
especially pages 93-101.
Rose, Peter S. 1994. Money and Capital Markets, Irwin, Boston.
TreasuryDirect website for purchasing U.S. Treasury securities
online:
http://www.publicdebt.treas.gov/sec/sec.htm
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