The rate for overnight loans backed by Treasuries in the $1.6 trillion-a-day market for borrowing and lending securities is approaching the highest level of the year as dealers’ need to fund holdings climbs.
The average rate for one-day repurchase agreements, or repos, was 0.124 percent yesterday, or just below the 0.134 percent level reached on June 16 that was the highest since November, a Depository Trust & Clearing Corp. index of General Collateral Finance repos shows. That compares with a rate of 0.01 percent at the end of last year.
“Seasonal collateral shortages are over, the Federal Reserve’s quantitative easing is winding down, and Treasury issuance is still relatively large,” said Scott Skyrm, the former head of repo and money markets for New York-based Newedge USA LLC who now runs a blog on the repo market. “This will help general collateral repo rates continue to rise relative to the federal funds rate over the coming months.”
The federal funds effective rate, which is the average for overnight loans among banks, was 0.1 percent yesterday.
In a general collateral repo transaction, the lender of funds is willing to accept a variety of Treasury, mortgage-backed securities or agency collateral. Securities dealers use repos to finance holdings and increase leverage. A repo agreement is a collateralized loan in which one party offers a security as collateral for a cash loan.
The Fed said this month that it would cut by another $10 billion to $35 billion its monthly purchases of Treasury and mortgage debt, known as quantitative easing, keeping it on pace to stop the program late this year. The central bank has kept its target rate for overnight loans between banks in a range of zero to 0.25 percent since December 2008.
As of June 11, the 22 primary dealers that trade directly with the Fed held $37.5 billion of Treasury coupon securities due in two years or less, up about zero at the end of February, Fed data show. Dealer holdings of Treasury bills are at $22.9 billion, up from $9.5 billion as the start of May.
“Increased collateral on dealer balance sheets is behind the higher repo rates,” Andrew Hollenhorst, fixed-income strategist at the primary dealer Citigroup Inc. in New York, wrote in a client note. “While we continue to think that increased collateral is playing an important role in pushing repo rates higher, we also acknowledge that less cash in the dealer community may be part of the story.”
The allotment at the central bank’s daily fixed-rate reverse-repurchase agreements, which are transactions conducted daily by the Fed Bank of New York, has fallen in recent weeks as the general collateral repo rates rose further above the 0.05 percent offered at the Fed facility. There was $119.7 billion in Fed reverse repos yesterday, and the daily usage reached as low as $53 billion.
Overall usage has risen from a $15 billion average in 2013, with the program beginning in September of last year at a 0.01 percent fixed rate. The Fed has steadily increased the per counterparty allotment cap, which is now $10 billion, and the rate, which currently is at the top of the range allowed by Fed guidelines for the program.
The Fed is using the fixed-rate reverse-repo facility to improve control of short-term borrowing costs and help facilitate the eventual unwinding of monetary stimulus. The facility will ultimately allow the Fed’s eligible tri-party reverse-repo counterparties, which range from banks to broker-dealer to money market funds, to lend the Fed unlimited amounts of cash overnight in exchange for Treasuries.
“You don’t have the supply pressures you used to have,” said Ira Jersey, an interest-rate strategist in New York at Credit Suisse Group AG, a primary dealer. “Many are using the Fed’s reverse repo facility, but everyone else still needs to get funding, so people can demand higher rates for the cash they loan.”