Treasury Asks Dealers for Ways to Boost TIPS Auction Demand

The U.S. Treasury Department asked the 21 primary dealers that trade government debt directly with the Federal Reserve to discuss supply and demand dynamics in the market for Treasury Inflation-Protected Securities.

Dealers were also requested to comment on “specialness and fails” of the repurchase-agreement market in March and June in “on-the-run” 10-year Treasuries. The Treasury plans to meet with the firms July 25-26, before it releases guidance on the amount of bill, note and bond sales in the quarter.

The survey is a routine practice before the Treasury makes its quarterly refunding announcement.

A shortage of the most-actively traded, known as the on-the-run, U.S. Treasury 10-year notes in the repurchase agreement market has caused traders to be willing to pay to borrow the securities in exchange for loaning cash, resulting in a negative repo rates. This has caused an increase of settlement failures, or fails. Negative repo rates reached an extreme prior at the Treasury’s sale of notes in June as well as in the month prior. Typically, lenders of cash receive interest on those loans, represented by a positive repurchase rate.

“When the note got so rich, at beyond minus 300 basis points in the repo market, people become indifferent between failing and paying the fails charge which leads to the propensity to fail,” said Joseph Abate, money-market strategist in New York at Barclays Plc, a primary dealer. “The question the Treasury is asking is if there is a way to prevent this. Unless they want to regularly issue more 10-year notes, which is unlikely, I don’t think there is really much they can do.”

Fails Penalty

Repo rates have traded below zero frequently since May 2009, when a 3 percentage point penalty for failing to meet security delivery obligations was put in place. The fee, instituted to reduce failed trades, means that at a repo rate below negative 3 percent it is more economical for a counterparty to fail to deliver than to obtain the needed security in the repo market.

The amount of incomplete deliveries, or fails, of Treasuries, excluding inflation-protected debt, rose to $157.271 billion in the week ended June 12, from $51.705 the week earlier, according to Federal Reserve Bank of New York data. Failures to deliver were at $62.541 billion in the Fed’s most recent weekly data as of July 3, after having retreated back to $53.160 billion as of June 26.

General Collateral

The overnight repurchase agreement, or repo rate, for the 1.75 percent note due in May 2023 opened at negative 0.35 percent today and closed at negative 0.10 percent, according to data from ICAP Plc, the world’s largest inter-dealer broker. The overnight general collateral Treasury repurchase rate closed at 0.08 percent.

In June, the repo rate for the 10-year note moved beyond negative 3 percent ahead of the auction of the securities.

Securities dealers use repos to finance holdings and increase leverage. 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.”

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