The Treasury Market's Big Short Is in 10-Year Notes, Repos Show

  • Overnight rate to borrow the security nears negative barrier
  • Repo shortage stoked as yield's drop brings out bears

Demand is so great for benchmark 10-year Treasuries in the $1.6 trillion market for borrowing and lending U.S. government debt, and supply is so short, that traders are willing to pay to lend cash to get their hands on the issue.

The overnight repurchase agreement rate on the newest 10-year note was negative 2.9 percent at noon New York time Monday, the lowest for any Treasury note or bond, according to ICAP Plc data. In the parlance of the repo world, that means the maturity is on ‘special,’ signaling heightened appetite for this specific security in deals where traders exchange the debt for overnight cash. In agreements lasting one month, the rate was as low as negative 1 percent last week, the most special since mid-2008, according to JPMorgan Chase & Co.

While securities often trade special in the days before auctions, the timing is unusual, coming so far in advance of the Treasury’s March 9 reopening of 10-year notes, said Stanley Sun at Nomura Holdings Inc. The heightened demand in repos probably stems from traders trying to borrow the security as part of betting against it after this year’s Treasuries rally made the debt expensive both outright and relative to other maturities, Sun said. Ten-year yields fell last month to the lowest since 2012.

“We haven’t seen at this particular point in the auction cycle the on-the-run 10-year note be so special in repo,” said Sun, a New York-based strategist at Nomura, one of the 22 primary dealers that trade with the Federal Reserve. “People have been trying to fade the rally of earlier this year.”

Yield Leap

Treasuries tumbled March 4 after a report on U.S. job growth sustained speculation the Federal Reserve will raise interest rates this year, following liftoff from near zero in December. The yield on the benchmark 10-year note was at 1.9 percent Monday in New York, after touching 1.53 percent Feb. 11.

The 10-year has also grown costly in comparison with other maturities. This month, a measure known as the butterfly spread showed it reached the most expensive since at least 2001 relative to five- and 30-year obligations.

A category of investors known as leveraged funds, which typically use borrowed money to boost returns, held net short wagers in 10-year Treasury futures of about 264,000 contracts as of March 1, up from about 198,000 the prior week, Commodity Futures Trading Commission data show.

Scarcity Factor

While futures traders have been short the maturity for about a year, the scramble in the repo market has intensified as the availability of the notes in cash dealings has dwindled.

The Treasury unveiled plans in February to reduce issuance of longer-term debt in coming months, while boosting offerings of bills to meet demand for short-term government obligations.

Securities dealers use repos to finance holdings and increase leverage. In repo agreements, one party provides securities as collateral to another in exchange for cash. Typically the side offering the cash receives, rather than pays, interest. Securities that can be borrowed at rates close to the Fed’s target -- at 0.36 percent Monday -- 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.’

Twist Ripple

Adding to the scarcity, the Fed doesn’t hold much of this particular issue to lend, Sun said.

Since Operation Twist, a 2011-2012 maneuver through which the Fed sold shorter-maturity Treasuries and bought longer-dated securities, the central bank has had fewer of the newest securities to lend out in a daily program it has to ease shortages. As a result, these Treasuries have frequently commanded a premium in the repo market -- leading more trades to even go uncompleted, or ‘fail,’ in bond lingo.

Repo rates have traded below zero frequently since 2009 after the Treasury Market Practices Group imposed a 3 percent penalty for uncompleted trades. The move was to combat an upswing in unsettled deals after the financial crisis fueled demand for Treasuries as a haven. The cost of incurring a negative repo rate to get securities needed to meet delivery obligations is more attractive than failing as long as the rate doesn’t reach negative 3 percent.

Traders are also seeking benchmark 10-year notes to short them against interest-rate swaps deals and as part of wagers related to Treasury Inflation Protected Securities, said David Keeble, the New York-based head of fixed-income strategy at Credit Agricole SA.

“We are going to special now, a bit before the normal pre-auction time, as there has been a mix of extra reasons to be short this particular note,” Keeble said. “This is more of a flash than a trend and we’ve seen these levels before. It’s not anything that I would suggest is breaking the market.”

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