Treasury 10-Year Note Repo Shortage Sends Rates Below Zero

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Treasury 10-year notes are in short supply in the $1.66 trillion-a-day market for borrowing and lending securities before the government’s sale of $21 billion of the notes Wednesday.

Traders are willing to pay to borrow the notes in the repurchase-agreement market in exchange for loaning cash overnight for the most actively traded 10-year maturity, with rates reaching negative 1.99 percent Wednesday, after sliding below negative 2 percent Tuesday, according to data from ICAP Plc tracked by Bloomberg.

Traders regularly short, or sell securities they’ve borrowed in the repo market, before a sale to profit if prices of the securities fall after the auction. The negative repo rates for 10-year notes Wednesday is less extreme than levels seen before past auctions -- some of which triggered the Treasury to investigate positions.

“There is a large short base in this issue, in part as people are using it as a hedge against some sizable real-money sales of other 10-year notes,” said Kenneth Silliman, head of U.S. short-term rates trading in New York at Toronto-Dominion Bank’s TD Securities unit. “There was also a slightly longer when-issued trading period for this sale than typical, so it forced dealers to build more shorts and overall for people to hold these bets longer. That has all helped richen the debt in repo.”

Auction Preview

The government sold the 10-year notes Wednesday at a yield of 1.925 percent, the lowest yield on a sale for this maturity debt since 2013. The pre-auction trading period is longer than average based on the timing of the auction versus the settlement date.

Hedge funds and other large speculators have net short positions in 10-year Treasury note futures of 113,810 as of March 31, according to Commodity Futures Trading Commission data.

Securities dealers use repos to finance holdings and increase leverage. In a repo agreement, one party provides securities as collateral to another in exchange for cash. 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 amount of uncompleted trades, known as fails, tends to rise when specific Treasuries are in very short supply in repo. As repo rates reach negative 3 percent, its often more economical for market participants to fail to make good on delivery commitments for the securities rather than risk being forced to pay a 3 percentage point penalty on uncompleted transactions.

Repo Market

In March 2013, after 10-year note repo rates slid to nearly negative 3 percent before that month’s auction, the Treasury Department asked for information about positions in the notes with a threshold of $2 billion as of the close of business, known as large-position reports that are used to analyze if anyone is trying to manipulate price movements.

The Treasury in February 2012 asked for similar positioning data, related to transactions in the seven-year note, which had also come into short supply in the repo market prior to a new auction.

“Issues often trade tight ahead of their auctions as dealers sell off inventory and investors that plan to be involved in the auction,” wrote Alan Chernoff, a fixed-income strategist at Stone & McCarthy Research Associates in Princeton, New Jersey.

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