The curve ahead
Amid the noise, August presents a tactical opportunity—if fiscal hurdles clear. With yields shifting, investors may eye short-term moves with cautious optimism.
US Treasury yields sold off in May, and it looked like they might hold those levels until market data and commentary from the US Federal Reserve (Fed) pulled yields lower, dropping about 20 basis points (bp) by the end of the month. Fed funds futures also followed suit, ending June 20 bp lower. Rates volatility was the name of the game as markets tried to separate meaningful signals from the usual noise. Spoiler alert: There was a lot of noise.
But one message came through loud and clear: The Fed is warming up to the idea of a rate cut. The probability of a 25 bp cut in September surged from 60% at the start of June to nearly 94% by month-end. Some Fed officials are starting to sound like they are on board. Christopher Waller said, “I think we’re in a position that we could do this as early as July.” Michelle Bowman supported a rate cut “as soon as July,” although the Chair Jerome Powell was of the opinion that “there is time to wait for more clarity,” and was supported by Susan Collins and Mary C. Daly. They seem to say, “We’re not cutting yet, but we’re definitely thinking about it.”
Cash on deck
Commercial paper yields mirrored the Treasury rally, and the demand for short-term credit remained strong. With cash balances still ballooning, investors were eager to put money to work. Credit spreads, however, did not budge (Bloomberg 1-3-year A+ option-adjusted spreads), which keeps us cautious on corporate credit.
Meanwhile, the Fed’s Reverse Repo Program (RRP) continues to act like a sponge, soaking up excess liquidity. At quarter-end, RRP usage hit $460 billion—up from $400 billion in Q1 and just shy of the $473 billion peak in December 2024. We expect this to drop sharply once the debt ceiling is raised and US T-Bill supply is unleashed—fingers crossed that Congress passes the Big Beautiful Bill (BBB) soon.
August advantage
Speaking of T-Bills, we have seen some strange behavior in the short end of the curve. A few weeks ago, a 2-month T-Bill auction tailed by 7 bp, and that kicked off a repricing of the August and September T-Bill curves. Why? There were two reasons:
- Debt ceiling drama: Investors are worried the US Treasury might run out of cash. At the time of writing, US Treasury’s checking account sits at $304 billion. That might sound like a lot, but as anyone who has been to Vegas knows, that can disappear fast. Estimates suggest the Treasury could run dry by August or September.
- Incoming supply tsunami: Once the debt ceiling is lifted, we are expecting $500–700 billion in new T-Bill issuance to refill the US Treasury’s checking account. That is a lot of paper, and is likely to push money market yields higher.
The result? A kink in the T-Bill curve. At the time of this writing there is a 10- to 15-bp spread between the July and August bills—an unusually wide gap. And with a Fed meeting scheduled for 30 July, those yields should be closer than 11 bp. The yield difference has been wider on an intraday basis, reflecting the uneasy feeling in the market. The 28 August bill before the curve slopes downward again.
So, where is the opportunity? If you believe the debt ceiling drama will pass without issue, we think there is value in those August bills. This situation is similar to June 2023, when increased T-Bill supply post the debt-ceiling-raise caused yields to rise. The risk, of course, is that the deficit hawks may delay action and cause chaos in the bill market. That is not our base case, but certainly something to be aware of. But as always, time (and Congress) will tell.