From time to time, Treasury money market funds offer higher yields than their Government counterparts. This dispersion is not intuitive as the market considers Treasuries to be more liquid and of higher credit quality than government agency debt. Also, while Treasury and Government funds differ in the eligible issuers allowed in each fund, they are generally composed of the same types of investments - repurchase agreements (repos), fixed-rate debt and floating-rate notes (FRNs), all managed within 2a-7 guidelines. We believe the reason for the yield relationship is two-fold: 1) the supply of U.S. Treasuries vs. agencies, and 2) the behavior of different FRNs in a rising rate environment.
With large and increasing U.S. fiscal deficits, the U.S. has increased Treasury issuance to fund the federal government. At the same time, issuance of agency debt - particularly Fannie Mae and Freddie Mac - has not kept pace. The result is a compression of spreads between T-bills and agency discount notes to somewhere between zero and three basis points (bps). In addition, the supply of bank repo collateral has increased and is decidedly skewed toward Treasuries. Here again, supply dynamics have compressed the spread between Treasury and agency repo yields to a single basis point at best, with many counterparties offering the same rate for both types of collateral. So for the repo and fixed-rate debt portions of these funds, the advantage for Government funds is likely no more than a basis point.
Further, given the greater supply of Treasury vs. agency collateral, Government money market funds often hold a significant portion of their investments in Treasury-backed repo, blurring the difference between fund composition and further muting any yield advantage for Government over Treasury funds.
Currently, most Treasury FRN holdings are based off the three-month T-bill auction and reset weekly. In a measured, Federal Reserve-driven rising rate environment, Treasury FRNs have the advantage of resetting weekly off a three-month index, a portion of which extends beyond the next anticipated rate hike which, in turn, raises the rate of the index. Government FRN holdings are typically based off one- and three-month LIBOR or federal funds, all of which may either not extend beyond the next projected rate hike or do not reset in a timely manner. To illustrate, since October 8th, the spread between three-month T-bills and one-month LIBOR has moved from a low of -7.1 bps to a high of +4.8 bps, improving the yield of Treasury FRNs vs. government FRNs. It is this yield advantage in FRNs which can push Treasury fund yields higher than Government funds. While the current yield advantage is likely not permanent, we expect market dynamics will keep future yield differentials to a minimum.