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U.S. 10-Year ‘Special’ Repo Status May Fade After Treasury Sale

Treasury 10-year notes will become less coveted in the short-term market for borrowing and lending the securities by next week as the government sells more of the debt, according to Bank of America Corp. and Barclays Plc.

Traders have been willing to pay to borrow the securities in exchange for loaning cash for the most actively traded 10-year note, which is the 2.125 percent security that matures in August 2021. Typically, lenders of cash receive interest on those loans, represented by a positive repurchase rate.

The overnight repo rate for the current 10-year note opened at negative 2.4 percent and traded at negative 2.85 percent at 10 a.m. New York time, according to data from ICAP Plc, the world’s largest inter-dealer broker. The overnight general collateral Treasury repurchase rate opened today at 0.13 percent and traded at 0.12 percent at 10 a.m.

“This is going to be a short-lived issue, with it being cleared up by next week when we get fresh 10-year note supply,” said Brian Smedley, a strategist in New York at Bank of America Merrill Lynch, in an interview. “It is not uncommon as you get late in the auction cycle to see some decline from the beneficial owners of the securities in their willingness to loan them out in repo. The investor base is sort of holding onto that issue and hasn’t been particularly active in lending them out.”

Repo Markets

Securities dealers use repos to finance holdings and increase leverage. Securities that can be borrowed at interest rates close to the Federal Reserve’s target rate, which now 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 Treasury will auction 10-year notes on Sept. 13 and provide more details tomorrow. It will sell 30-year bonds on Sept. 14.

The Fed owns about $735 million of the 2.125 percent coupon Treasury note that matures in August 2021 in its System Open Market Account, or SOMA, as of Aug. 31, according to data on the Federal Reserve Bank of New York’s website. That is equivalent to only 2.97 percent of the amount outstanding.

The Fed offers specific Treasury securities held in 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.

Low Yields

The yield on 10-year notes advanced to 2.03 percent today from an all-time low of 1.9066 percent yesterday, according to Bloomberg Bond Trader prices.

As the 10-year note has become more in demand in the repo market, the amount of incomplete deliveries, or fails, rose to about $55 billion a day during the first two days of September from about $7.5 billion a day in August, according to Barclays.

Speculation has risen since the Labor Department reported last week that job creation stalled in August that the Fed may as early as at this month’s Federal Open Market Committee increase its purchases of longer-term Treasuries to narrow the difference between short- and long-term borrowing rates in hopes to boost economic growth, a policy known as “Operation Twist.”

“When the issue is reopened next week, much of the richness in the on-the-run 10-year Treasury note in the repo market will fade,” said Joseph Abate, money-market strategist in New York at Barclays. “As talk about Operation Twist picks up ahead of the FOMC meeting, we expect cash long positions in the 10-year sector to build in anticipation of sales to the Fed. As dealers ramp up these positions, financing demand should rise, potentially pushing general collateral repo rates higher.”

Maturity Extension

Fed Chairman Ben S. Bernanke has cited extending the average maturity as one of monetary stimulus tools available to policy makers. Economists with the Fed’s regional bank in San Francisco wrote in April that “Operation Twist,” a 1961 initiative by the central bank and President John F. Kennedy’s administration, spawned a 0.15 percentage point reduction in long-term Treasury yields.

Pacific Investment Management Co., Goldman Sachs Group Inc. and Bank of America are among those that expect the central bank to announce plans to raise the average maturity of its bond portfolio by selling shorter-term debt and reinvesting proceeds from maturing securities into longer-term bonds.

The average rate for borrowing and lending Treasuries for one day in the repo market was 0.114 percent yesterday, according to index data provided by the Depository Trust & Clearing Corp. That was up from 0.095 percent on Sept. 2. The index level was below zero, at negative 0.002 percent as recently as July 14.

DTCC Index

The DTCC index is a weighted average of all general collateral repo transactions during a day. The DTCC processes about $3.6 trillion in repos transactions daily.

The current 10-year note may become more “special” in the repo market if dealers step-up bets that the yield gap between 10- and 30-year securities narrows upon the Fed announcing an “Operation Twist” program, according to Jerome Schneider, head of the short-term strategies and money markets desk at Newport Beach, California-based Pacific Investment Management Co. Such a trading strategy involves selling 10-year notes and buying 30-year bonds, creating demand to borrow the 10-year notes in the repo market to cover short positions.

“This is probably the most stressful point in the repo markets for the 10-year unless curve-flattening trades pick-up,” Schneider said in an interview. “The week before new supply comes is typically the heaviest week in terms of how special things become as the repo market searches for supply to cover shorts in the cash markets.”

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