Fed Dealer Borrowing Hits Almost 1-Year High After FOMC Reading

Primary dealers borrowed the most Treasuries from the Federal Reserve yesterday in almost a year amid speculation they sought to unwind bets that debt prices would fall.

Lending of U.S. notes and bonds in the central bank’s daily program rose to $21.57 billion, an increase of 10 percent from the Feb. 20 level and the highest borrowing by dealers since March 2012. Total Treasuries lending rose to $22.28 billion, also the highest since March, according to data on the New York Fed’s website.

Treasuries rallied Feb. 20 after the central bank released minutes of its policy-making committee meeting Jan. 29-30 that showed continued debate about how long to undertake open-ended bond buying to bolster the economy. Minutes from the Dec. 12 meeting, released Jan. 3, had fueled short position, or wagers that Treasuries would fall, on speculation the central bank may curtail monetary stimulus sooner that forecast.

“This week’s FOMC minutes were viewed going into them as having a larger risk to be hawkish or that is negative for the Treasury market,” said Ian Lyngen, a government bond strategist at CRT Capital Group LLC in Stamford, Connecticut. “At least anecdotally, as well as through some of the surveys, there seemed to be a reasonable short base going into the minutes. The fact that the Fed didn’t come out in any particularly hawkish way led to a bit of a rally.”

Yield Path

The Treasury 10-year note yield reached close to the highest in 10 months on Feb. 20. The yield, which touched 2.05 percent, fell to 1.97 percent today in part as the minutes provided a less clear signal on the Fed’s exit plan.

Fed officials “emphasized that the committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved,” according to the January minutes.

Primary dealers expect the Fed to reduce the pace of asset purchases by the beginning of 2014, with a majority anticipating an end to mortgage-bond purchases by January, a survey showed. The median respondent in the survey by the Fed Bank of New York saw the central bank buying $20 billion in Treasuries per month and no mortgage securities in January 2014, according to the survey conducted before the FOMC meeting.

The central bank is buying $85 billion in Treasury and mortgage debt a month as part of its third round of quantitative easing, aimed to keep long-term interest rates low to bolster growth.

’Short Base’

“There was a short base that kind of got squeezed out with them expecting the minutes to follow those from the December FOMC, which had gone into a little bit more detail about the Fed’s balance sheet than people had anticipated,” said Todd Colvin, a senior vice president at futures broker R.J. O’Brien & Associates in Chicago. “These minutes were kind of a tug of war. They had sort of a more dovish tone than expected and you saw the market get squeezed.”

Last week, Treasury sold $32 billion of three-year notes, $24 billion 10-year notes and $16 billion of 30-year bonds. After the Treasury completes sales of new debt, dealers typically look to cover shorts build up before the auctions, which they’re required to bid on.

The Fed offers Treasury securities held in its System Open Market Account, or SOMA, for loan on an overnight basis to dealers against Treasury general collateral. Dealers bid in a multiple-price auction held every day at noon New York time.

When securities are hard to obtain in the outright or repurchase agreement market, dealers can go to the Federal Reserve Bank of New York to borrow the debt through its SOMA Securities Lending Program. Demand for specific securities typically rises when dealers have to cover so-called short positions, or bets Treasury prices will decline.

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