The amount of securities borrowed daily from the Federal Reserve by the central bank’s primary dealers surged to a 10-month high with some maturities in short supply amid this week’s U.S. debt auctions.
When securities are hard to obtain in the repurchase agreement 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 build 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 borrowing of securities in the repo market. Securities that can be borrowed at interest rates close to the Federal Reserve’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 rise in SOMA borrowings is likely an indicator of an increase in core shorts in the market, and an indicator of why general collateral repo rates have been lower in the latter half of the day over the past week,” said Kenneth Silliman, head of U.S. short-term rates trading at Toronto-Dominion Bank’s TD Securities unit in New York. “Dealers have had to provide an increasing amount of collateral to the Fed to secure these borrowings, which has created late-day imbalances in the repo market.”
The U.S. sells $35 billion of five-year notes today, the second of three auctions of coupon-bearing debt this week totaling $99 billion. The U.S. sold $35 billion of two-year notes yesterday and will auction $29 billion of seven-year securities tomorrow.
SOMA lending of Treasury notes and bonds rose to $20.179 billion yesterday, an increase of 30 percent from the prior day’s level. Lending has risen each of the past five days, and is up from $4.903 billion on Jan. 18.
Five-, seven- and 10-year year become coveted in the repurchase agreement before the government auctions of the debt this week. Traders have been willing to pay to borrow the securities in exchange for loaning cash for the most actively traded of these Treasury notes, meaning overnight repo rates are negative. The opening repo rate for the on-the-run five-year Treasury note was negative 0.15 percent, while that for the seven-year was negative 0.1 percent and the open for the 10-year was negative 0.03 percent.
The general collateral repo rate for Treasuries fell below zero yesterday, touching negative 0.05 percent during the afternoon, according to TD Securities.
Typically, lenders of cash receive interest on those loans, represented by a positive repurchase agreement, or repo, rate. Many times traders short, or sell securities they’ve borrowed in the repo market, before a Treasury sale to profit if prices of the securities fall after the auction.
Securities dealers use repos to finance holdings and increase leverage.
The Fed has also been purchasing debt in some of the maturity areas that the Treasury is issuing securities this week, removing available notes in the secondary market.
The Fed bought $3.357 billion of Treasuries maturing from February 2020 to November 2022 today as part of its latest round of quantitative easing aimed at keeping borrowing costs low, according to the Fed Bank of New York’s website. The central bank is purchasing $85 billion of government and mortgage debt each month.
The overnight Treasury general collateral repurchase agreement rate opened today at 0.1 percent, according to ICAP Plc, the world’s largest inter-dealer broker.
The average rate for borrowing and lending Treasuries for one day in the repo market was 0.082 percent yesterday, according to index data provided on a one-day lag by the Depository Trust & Clearing Corp. The index touched as low this year as 0.08 percent on Jan. 22, down from 0.29 percent at the end of last year.
“The Fed has been buying some of these sectors, the seven-year in particular, which has caused it to really richen in repo, and the central bank has had to lend out more because it’s the most on special,” said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, a primary dealer. “This is not unusual seasonally, as we’ve seen a spike in SOMA lending at this time during the past two years.”