Why Treasury Bill Yields Can Fall Below the Fed Reverse Repo Rate
Summary
The document asks why some Treasury bills can yield less than the Federal Reserve’s overnight reverse repo rate, despite the apparent safety of placing cash directly with the Fed. Its explanation is market segmentation: investors differ in which markets and facilities they can access, and those differences affect demand and yields. Investors such as some funds and central banks may be able to buy Treasury bills while being unable to participate in repo transactions, adding demand for bills and pushing their yields lower.
The answer also points out that institutions eligible for repo are not necessarily limited to lending to the Fed or holding bills. They may have access to other relatively safe assets and counterparties offering higher yields. The discussion is qualitative and tied to the market conditions described in the question, including a debt ceiling episode. It gives no quantitative decomposition of the yield gap, and access rules, rates, and relative valuations can change over time.
Key ideas
- Differences in investor eligibility can segment Treasury bill and repo markets.
- Investors unable to use repo may still add demand for Treasury bills, lowering bill yields.
- Repo-eligible institutions can consider other assets and counterparties beyond the Fed.
- A yield comparison alone does not establish that one instrument is uniformly safer or more attractive.
- The explanation is qualitative and reflects a particular market setting.
Tags
Full text
# Why are T-bills yielding lower than the reverse repo rate? # Why are T-bills yielding lower than the reverse repo rate? With another US debt ceiling debacle looming, I just realized something that runs against my intuition: Many of the Treasury bills maturing in 6 months (with the exception of the ones maturing near and right after the debt ceiling becomes binding) are yielding lower than reverse repo (RRP) rate set by the Fed. For example, the yield of the bills maturing in December 2021 are around 0.02% right now, e.g. according to quotes at https://www.wsj.com/market-data/bonds/treasuries. This is less than half of what you would get if you park money at the RRP facility at the Fed, which is 0.05% at the moment. (Of course, the exceptions being the bills maturing in Oct 2021, which are affected by the debt ceiling.) It seems that over-night reverse repo, in which one deals with the Fed and receive Treasuries as colleterals, should be safer than investing in T-bills out-right, and RRP should yield lower than T-bills. Apparently this is not what's happening in the market, so I must be missing something! I'd appreciate if someone can provide some insight into this! One explanation I heard is market segmentation. T-bills market is open to the public, while Fed's RRP facility (and of course, IORB) is limited to a select number of counter-parties. This begs the question: why should institutions who are eligible to use RRP facility hold any Treasury bills that are yielding lower than 5 bps? OK I've almost convinced myself that this is due to market segmentation. There are investors who are ineligible to lend in the RRP facility, and have to buy bills, therefore pushing yields down. ## Answer by Si Chen (score 3, accepted) https://quant.stackexchange.com/a/68126 Yes, it is definitely because of market segmentation. On one hand there are many funds, central banks, etc. who can buy treasury bills and cannot engage in repos. On the other hand, entities which can do repo have a wider range of allowed assets and counterparties. They're not restricted only to treasury bills or only the Fed, so they can earn higher yields on other "relatively safe" assets with other "relatively high quality" counterparties.
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