Short-Term U.S. Rates Rise Post-Fed as Dealers Work on Year End

  • DTCC repurchase index reaches its highest level since 2009
  • Yields on Treasuries of all maturities climb amid auctions

A measure of U.S. short-term borrowing costs reached the highest level since 2009 as the Federal Reserve’s policy tightening combined with the typical bent of dealers to shore-up balance sheets at the end of the year.

Overnight rates for Treasuries in the market for general collateral finance repurchase agreements between dealers tracked by a Depository Trust & Clearing Corp. index reached Monday the highest since 2009, or as far back as the firm provides data. U.S. debt yields of all maturities were higher Tuesday before sale of $35 billion of five-year notes, following Monday’s sale of $26 billion of two-year securities.

Debt markets have adjusted fairly seamlessly since the Fed raised its rate target on Dec. 16, even as central bank use of new tools to engineer the move had raised operational concern. The federal funds effective rate, repurchase rates and the London interbank offered rate, have all drifted higher and trade above the 0.25 percent offered on the Fed’s reverse-repos facility -- the base for the central bank’s increased target band.

“The universal phenomena of dealers cutting balance sheet at year-end is contributing factor and overall because the Fed is showing pretty good control over front-end rates,” said Aaron Kohli, a fixed-income strategist in New York for BMO Capital Markets, one of 22 primary dealers that trade with the Fed.

The DTCC GCF Treasury repo index rate was 0.549 on Dec. 28, up from 0.539 percent on Dec. 24 and 0.183 percent at the start of the month. The index is a weighted average of all general collateral repo transactions during the day.

General collateral repo rates opened Tuesday at 0.5 percent, down from 0.63 percent on Monday, according to ICAP Plc, the world’s largest inter-dealer broker. The repo rate for the benchmark two-year note opened at minus 2.7 percent. Rates on specific securities that trade well below the general collateral rate are deemed "on special.”

Special repo rates for two-year notes and increased short positioning in futures has likely also contributing to a increase the amount of uncompleted trades, known as fails, Kohli said. Fails tend to rise when specific Treasuries are in very short supply in repo.

Total U.S. Treasury settlement delivery failures, excluding inflation protected securities, were $192 billion in the week ended Dec. 16, according to the latest available Fed data. That compares to a weekly average this year of $78 billion. Fails reached a record $2.7 trillion in October 2008 during the financial crisis.

Market Positions

Hedge funds and other speculators had net short positions in two-year Treasury note futures of 118,261 contracts as of Dec. 22, an increase from net shorts of 99,666 a week earlier, according to Commodity Futures Trading Commission data.

“The two-year Treasury has been the pain point with it on-special with rates falling, as people are getting more emboldened to sell it," Kohli said. "There is a large short-base in the two-year.”

Securities dealers use repos to finance holdings and increase leverage. They typically involve the sale of U.S. government securities in exchange for cash, with the debt held as collateral for the loan.

Money market mutual funds are among the predominant lenders of cash in such transactions. Dealers agree to repurchase the securities at a later date, and cash is sent back to the lender. Higher repo rates thus increase the cost for financing debt holdings.

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