Treasuries Aren’t So Special in Repo Market as Fed Bets Deferred

The $1.6 trillion market where dealers go to borrow U.S. government debt is adding to signs that Treasury bears are in retreat less than a month before a potential Federal Reserve interest-rate increase.

Typically, when there is heightened interest in shorting Treasuries -- meaning bet they’ll decline -- the securities are in demand in the repurchase agreement market as traders try to obtain the debt to sell. In the argot of repo traders, that’s known as being “on special.”

Yet that phenomenon is barely in evidence, signaling traders aren’t gearing up for bond losses with the Fed’s Sept. 17 decision looming. Minutes from the central bank’s July policy meeting, released Wednesday, showed officials are concerned about stubbornly low inflation, leading traders to scale back odds of a rate boost next month.

There “has been the lack of specials volume,” said Joseph Abate, a money-market strategist in New York at Barclays Plc, one of the 22 primary dealers that trade with the Fed. “People really aren’t that short in the cash Treasury market.”

Dealers use repos to finance holdings and increase leverage, lending cash in exchange for Treasuries. The more eager they are to obtain a security, the lower the rate at which they’ll lend money to get it. Securities that can be borrowed at rates close to the Fed’s target, now in a range of zero to 0.25 percent, are called general collateral. Those borrowed at lower rates are called on special.

Repo Signal

The average rate for borrowing and lending Treasuries for one day in the repo market was 0.205 percent on Thursday, according to the Depository Trust & Clearing Corp.’s general collateral finance Treasury Repo index. The benchmark two-year Treasury note, the security that has been most on-special this month, was at a repo rate of negative 2.24 percent at about 8 a.m. New York time Friday, according to ICAP Plc, the world’s largest inter-dealer broker.

Fed policy makers have yet to see conditions for the first rate increase having been reached, even though they “were approaching that point,” the minutes from their July gathering showed.

Futures show a 32 percent chance the Fed will raise its benchmark rate at its Sept. 16-17 meeting, based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase. The probability was 48 percent at the end of last week.

Treasury bears are also in the minority in the futures and cash markets. Hedge funds and other large speculators had net long positions in 10-year Treasury note futures as of Aug. 11, according to Commodity Futures Trading Commission data.

Government debt has rallied this week as slumping equity prices fueled investors’ quest for a haven.

“There isn’t a big natural short-base in Treasuries,” said Thomas Simons, a government-debt economist at Jefferies Group LLC. “It’s just very hard to be short out there, as that trade has proven to be a widowmaker for a long time now.”