Treasury Notes Turn Special in Repo Market Amid Debt Auctions
Treasury notes with maturities ranging from two to seven years have become coveted in the short-term market for borrowing and lending securities as the government auctions more of the securities this week.
Traders have been willing to pay to borrow the debt in exchange for loaning cash for the most actively traded five-, seven- and 10-year notes, with repurchase agreement rates negative. Many times traders short, or sell securities they’ve borrowed in the repo market, ahead a Treasury sale to profit if prices of the securities fall after the auction.
The overnight repo rate for the current five-year note closed at negative 0.30 percent, while that on the seven-year ended at negative 0.10 percent and the 10-year was negative 0.01 percent, according to data from ICAP Plc, the world’s largest inter-dealer broker. The overnight general collateral Treasury repurchase rate closed at 0.04 percent
“The auctions this week are a significant factor causing the specials in the repo market,” John Canavan, a fixed-income strategist at Stone & McCarthy Research Associates in Plainsboro, New Jersey, said in a telephone interview. “There are some broader collateral-shortage issues at the moment also, which is why the general collateral rate has been falling. But the primary reason you are seeing the five’s and seven’s specialness increasing is because we are heading into the auctions.”
The U.S. sold $34 billion in two-year notes today at a lower-than-forecast yield as concern turmoil in Syria may lead to wider military conflict boosted refuge demand. The notes drew a yield of 0.386 percent, compared with a forecast of 0.390 percent in a Bloomberg News survey of seven of the Federal Reserve’s 21 primary dealers.
The average rate for borrowing and lending Treasuries for one day in the repo market was 0.035 percent yesterday, according to the DTCC GCF Treasury Repo index. That rate has fallen from 0.29 percent at the end of last year. The repo rate decline has come as the Fed has kept its target rate for overnight loans between banks locked in a range of zero to 0.25 percent since December 2008.
Securities dealers use repos to finance holdings and increase leverage. Securities that can be borrowed at interest rates close to the Fed’s target rate, which is in a range of zero to 0.25 percent, are called general collateral. Those in highest demand have lower rates and are called “special.”
The two-year note sale was the first of three note auctions this week totaling $98 billion. The government will sell $35 billion in five-year debt tomorrow and $29 billion in seven-year securities on Aug. 29.
The Fed has been purchasing Treasuries, limiting the amount available to borrow and lend in the repo market, as part of its third round of debt purchases known as quantitative easing. The central bank is buying $45 billion Treasuries and $40 billion in mortgage debt each month.
Given the scarcity of Treasuries in repo due to the Fed’s debt purchases, the amount of securities borrowed daily from the central bank by primary dealers has risen this year. When securities are hard to obtain in the repo market, dealers can go to the Federal Reserve Bank of New York to borrow the debt. Demand for specific securities typically rises when the Treasury is selling debt, as dealers look to cover so-called short positions built up before the auctions they’re required to bid on. A short is a bet a securities price will fall.
The Fed offers Treasury securities held by its System Open Market Account, or SOMA, for loan to dealers against Treasury general collateral on an overnight basis. Dealers bid in a multiple-price auction held every day at noon New York time. This differs from the borrowing of securities in the repo market.
SOMA lending of Treasury notes and bonds averaged $15 billion a day this year, compared with an average of $10.5 billion last year, Fed data shows.
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