How Are Treasury Bill Interest Rates Determined? (2024)

U.S. Treasury bills (T-bills) are typically sold at auction for a discount from their par value. Unlike other U.S. Treasury securities such as Treasury notes (T-notes) and Treasury bonds (T-bonds), T-bills do not pay periodic interest at six-month intervals. Therefore, the interest rate for Treasuries is determined through a combination of the total discounted value and the maturity length.

T-Bill Auctions and Types of Bidders

The Treasury holds auctions for different maturities at separate, reoccurring intervals. Auctions for the 13-week and 26-week T-bills happen every Monday as long as the financial markets are open during the day. Fifty-two-week T-bills are auctioned every fourth Tuesday. Each Thursday, announcements are made about how many new T-bills will be issued and their face values. This allows potential buyers to plan their purchases.

There are two types of bidders for Treasury bills: competitive and noncompetitive. Competitive bidders are the only ones who actually influence the discount rate. Each competitive bidder declares the price they are willing to pay, which the Treasury accepts in descending order of price until the total face value of any particular maturity is sold out. Noncompetitive bidders agree to buy at the average price of all accepted competitive bids.

Face Value Redemption and Interest Rate

Buyers who hold T-bills until maturity always receive face value for their investments. The interest rate comes from the spread between the discounted purchase price and the face value redemption price.

For example, suppose an investor purchases a 52-week T-bill with a face value of $1,000. The investor paid $975 upfront. The discount spread is $25. After the investor receives the $1,000 at the end of the 52 weeks, the interest rate earned is 2.56% (25 / 975 = 0.0256).

The interest rate earned on a T-bill does not necessarily equal its discount yield, which is the annualized rate of return the investor realizes on an investment. Discount yields also change throughout the life of the security. The discount yield is sometimes called the discount rate, which should not be confused with the interest rate.

Treasury Bill Pricing and Market Impact

Several external factors can influence the discount price paid on T-bills, such as changes in the federal funds rate, which impacts T-bills more than other types of government securities. This is because T-bills directly compete with the federal funds rate range in the market for low-risk, short-term debt instruments. Institutional investors are particularly interested in the federal funds rate range and T-bill yields because they help them analyze investment risk.

The prices for Treasury bills (T-bills) can have a significant impact on the risk premium charged by investors across the entire market. T-bills are priced like bonds; when prices rise, yields drop. When they fall, yields rise. They act as the closest thing to a risk-free return in the market; all other investments must offer a risk premium in the form of higher returns to entice money away from Treasuries.

Other Influences on T-Bill Pricing

There are other drivers of T-bill prices. During times of high economic growth, investors are less risk-averse, and the demand for bills tends to drop. As T-bill yields rise, other interest rates rise as well. Other bond rates climb, the required rate of return on equities tends to rise, mortgage rates tend to rise, and the demand for other "safe" commodities tends to drop.

Similarly, when the economy is sluggish and investors leave riskier investments, T-bill prices tend to rise, and yields drop. The lower T-bill interest rates and yields drop, the more investors are encouraged to look for riskier returns elsewhere in the market. This is particularly true during times when inflation rates are higher than the returns on T-bills, essentially making the real rate of return on T-bills negative.

Inflation also affects T-bill rates. This is because investors are reluctant to purchase Treasuries when the yield on their investments does not keep up with inflation, making the investment a net loss in terms of real purchasing power. High inflation can lead to lower Treasury prices and higher yields. Conversely, prices tend to be high when inflation is low. The second reason inflation affects T-bill rates is because of how the Federal Reserve manages the money supply.

The Bottom Line

Treasury Bill interest rates are determined using their term and total discounted value. This is also called a coupon eqivalent by the U.S. Treasury.