The U.S. Budget Deficit and a T-Bill Yield High

The markets have been more tumultuous than usual in recent days.  There were two important developments for investors, but many likely missed.

First, yesterday the US reported the November budget deficit. At $56.8 bln, it was more than 10% less than economists’ projections.  The budget shortfall in November 2013 was $135.2 bln.

The new fiscal year is two months old.  Thus far, the budget deficit for the FY15 is $178.5 bln down from $225.8 bln in the first two months of the last fiscal year.   

The markets have been more tumultuous than usual in recent days.  There were two important developments for investors, but many likely missed.

First, yesterday the US reported the November budget deficit. At $56.8 bln, it was more than 10% less than economists’ projections.  The budget shortfall in November 2013 was $135.2 bln.

The new fiscal year is two months old.  Thus far, the budget deficit for the FY15 is $178.5 bln down from $225.8 bln in the first two months of the last fiscal year.   

As a percentage of GDP, the deficit was 2.8% last year.  Projections are 2.6% this fiscal year.  The US is to where many countries in Europe want to go; an improving, if not yet completely healthy, labor market, growth that is on balance somewhat above prevailing interest rates, and a budget deficit that is less than 3% of GDP.   

The path the US took seemed perverse to many.  The US adopted aggressive monetary and fiscal policies to address a debt crisis relatively early on.  This produced large budget deficits, which translated into greater debt.  The budget deficit peaked at over 10% of GDP.  It took a couple of years to demonstrate the superiority of the US strategy over that deployed by Europe, under Germany and other creditors’ tutelage.  

Second, the US one-year T-bill rate hit a three-year high yesterday of nearly 23 bp.  It essentially doubled from the end of last month.  It is especially noteworthy because heavy losses in the equity market typically see lower Treasury yields as investors flock to security.

There are two culprits.  The first is supply.  Bill issuance appears to have increased.  The second is what appears to have been lost on many.  For the second time in a month, on December 1, the Federal Reserve raised the rate it pays on its daily repo operations.  The rate now stands at 10 bp, which is good through tomorrow.  

At the same time, we note that the effective Fed funds rate firmed this month.  It might not seem like much, but at 12 bp, the effective rate is the highest in eighteen months.  It has been averaging 8-10 bp in recent months.   Ideas that the Fed may expunge or dilute the reference to a “considerable period” in next week’s FOMC statement does not explain this modest drift higher.  It does appear that the higher rate on the Fed’s reverse repo operations is providing banks with an alternative place to park funds.  

The Federal Reserve is developing the tools that it will employ to manage huge volume of excess reserves when it raises interest rates.  Given the higher bill and Fed funds rates, Fed officials may be confident that they will be prepared to raise rates when the time comes.

Two US Developments that if You Blinked You Missed is republished with permission from Marc to Market