Failed Trades in 10-Year Treasury Soar as Note Stays `Special'

  • Slide in repo rates lifts costs and unsettled trades
  • Short wagers against the notes spur demand to borrow

The shortage of benchmark 10-year Treasury notes in the market for borrowing and lending U.S. government debt has become so pronounced that uncompleted trades are soaring.

Such trades, known as fails, surged into the billions of dollars in recent days for the newest 10-year note, and may have been in the range of $6 billion to $12 billion, according to Treasury market participants familiar with the matter who requested anonymity because the figures aren’t public. While uncompleted trades occur daily, sometimes because of computer glitches, it’s unusual for the level to be so high. There were $132 million in failures for all 10-year Treasuries in the week ended Feb. 24, the latest data from the Federal Reserve Bank of New York show.

Stress is emerging in the repurchase-agreement market, where dealers lend debt in exchange for overnight cash, after 10-year yields fell last month to the lowest since 2012. So many traders are amassing short bets on the on-the-run Treasury, or wagers that yields will rise, that they’re struggling to find the note to close out the positions. In a sign of climbing demand for the newest 10-year, the overnight repurchase agreement rate was negative 3 percent at noon New York time Wednesday, according to ICAP Plc data. The rate for benchmark 30-year bonds was negative 2.7 percent. A negative rate means dealers were willing to pay to lend cash to obtain the issue.

Plumbing Problem

“Investors have to think a lot more about this plumbing, that people tend to take for granted, which doesn’t work perfectly at times and can have an impact on an overall trade,” said Aaron Kohli, a fixed-income strategist in New York at BMO Capital Markets, one of the 22 primary dealers that trade with the Fed. “It suggests there is a bit of fragility in the Treasury market.”

To curb fails amid demand for U.S. government debt during the financial crisis, the Treasury Market Practices Group, an advisory committee, imposed a 3 percent penalty for uncompleted trades in 2009. Since then, repo rates have occasionally dropped below zero, and these days fails typically don’t heat up until repo rates reach about negative 3 percent. At that level, the fee incurred for not settling trades would be the same as the cost of obtaining them in repo.

Settlement delivery failures of all Treasuries, excluding inflation-protected securities, tallied $70 billion in the week ended Feb 24, Fed data show. They set a record $2.7 trillion in 2008. The New York Fed updates the data Thursday, and it may show fails rising.

Securities that can be borrowed at rates close to the Fed’s target -- at 0.37 percent in market trading Wednesday -- are called general collateral. The general collateral rate was 0.44 percent, according to ICAP. Securities with repo rates well below the general collateral rate are deemed on ‘special.’

Auction Prep

In the days just before auctions, debt often trades on ‘special’ in the repo market, meaning there’s heightened demand for the specific security. Yet in this case, the phenomenon surfaced last week, well in advance of the Treasury’s $20 billion reopening of the notes Wednesday. The imbalance typically fades after the new securities settle, which for this note will be March 15.

“There is for some reason incredible demand for this security,” said Jim Combias, New York-based head of Treasuries trading at Mizuho Securities USA Inc., another primary dealer.

Fed’s Role

The Fed owns $1.8 billion, or about 7 percent, of the on-the-run 10-year, which it can lend to dealers daily to ease shortages, according to data from the New York Fed. That hasn’t been sufficient to ease the logjam.

“The Fed doesn’t own a lot of the on-the-run issues,” said Guy Haselmann, head of capital-markets strategy in New York at Bank of Nova Scotia, a primary dealer. “Usually when there is something that is super special, or there is a problem, the Fed can lend them and ease it. What can also kind of cause a squeeze in repo is that there is a real-money, end-user buyer that just doesn’t lend them out.”

The strains in repos are fueling speculation the Treasury Department will request information on large holders of the note, as it’s done in the past when there were shortages. Treasury has conducted 14 calls for large positions since the reporting program took effect in the 1990s in the aftermath of the Salomon Brothers bond-market scandal. The aim is to guard against market manipulation, such as efforts to corner the supply of a security to drive up the cost of closing short positions.

Treasury Call

“I’m sure the Treasury will call for large position reports,” said Priya Misra, head of worldwide interest-rates strategy in New York at TD Securities (USA) LLC, a primary dealer. “They will be concerned if there is any evidence of a squeeze or deliberate behavior. Treasury may wait to see if the specialness in repo persists after the auction securities settle.”

Treasury spokesman Rob Runyan declined to comment on the potential for the government to seek large position data on benchmark 10-year notes.

In March 2013, after 10-year Treasury repo rates slid to nearly negative 3 percent before an auction, the Treasury Department asked for information about positions of at least $2 billion in the notes. In February 2012, Treasury asked for similar data on seven-year notes.

The U.S. amended the rules, effective March 2015, for reporting large holdings in certain Treasury securities. The changes included requests that foreign central banks and governments and international monetary authorities, all of which were formerly exempt, also submit data. The U.S. also replaced the $2 billion threshold with a percentage -- 10 percent of the outstanding amount of the given Treasury.

“The Treasury wants to maintain a liquid market -- especially in the on-the-runs, and does large position reports at times to make sure there is no hoarding going on,” said Thomas Simons, a government-debt economist in New York at Jefferies Group LLC, a primary dealer.

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