Download Pressure in Repo Market Spreads

Pressure in Repo Market Spreads
Stresses amplify price swings in government bonds
By
Katy Burne
April 2, 2015 6:23 p.m. ET
6 COMMENTS
A shortage of high-quality bonds is disrupting the $2.6 trillion
U.S. market for short-term loans known as repurchase
agreements, or “repos,” creating bottlenecks for a key source
of liquidity in the financial system and sending ripples through
short-term debt markets.
Stresses in the repo market are amplifying price swings in government bonds and related
debt markets at a time when many investors are reshuffling their portfolios around new
interest-rate expectations, following a period of low volatility, traders and analysts said.
Although traders said the impact so far has been
manageable, the broad concern is that scarcity in repos
will pressure rates and could complicate efforts by the
Federal Reserve to lift interest rates when the time
comes.
Problems in the repo markets have been the subject of
discussions at the U.S. Treasury, people familiar with the
matter said. Since there is typically a strong relationship
between repos and overall bond markets, the shifts can
influence trading in everything from U.S. Treasurys to
commercial paper, short-term IOUs taken on by companies.
“The less repo, the less liquidity in bond and other markets,” said Josh Galper,
managing principal at consultancy and research firm Finadium LLC. RECALL
THAT LIQUIDITY IS A DESIRABLE QUALITY IN ASSETS!
ENLARGE
Repos have been a topic of discussion at the Treasury. Photo: Andrew Harrer/Bloomberg
News
In repos, investors such as hedge funds swap bonds in
exchange for cash, often overnight, promising to repurchase
the bonds later at an agreed-upon price. An obscure but
pivotal corner of the financial world, repos allow investors
such as hedge funds to borrow to finance their investments
(THIS IS CALLED MATURITY TRANSFORMATION BORROW SHORT, LEND (INVEST) LONG SEE SLIDE
FROM STEIN!) while providing a place for money-market
funds to earn a return on their piles of cash (YES, THIS IS
MY RETURN ON MY RETIREMENT ACCOUNT!). Banks
typically act as middlemen between repo lenders and
borrowers for a fee. (REFERRED TO AS A TRI-PARTY
REPO! THIS IS THE WAY THE FED CURRENTLY DOES
IT IN THEIR 'EXPERIMENTAL REVERSE REPO
FACILITY' THE BANKS ARE JPMORGAN CHASE AND
THE BANK OF NEW YORK MELLON (LUCKY 'DOGS'!)
SLIDE FROM STEIN (2015)
SO WE ARE CLEARLY IN A POSITION WHERE DEMAND EXCEEDS
SUPPLY - WE CAN'T DO MUCH ABOUT DEMAND NOR SHOULD WE
(THINK OF THE ECB AND QUANTITATIVE EASING - MANY CAPITAL
FLOWS TO US MARKETS - EUROPEAN RATES ARE SUPER LOW BY
DESIGN - RATES ARE HIGHER IN US). WHAT WE CAN DO IS SOMETHING
ABOUT SUPPLY - BACK TO THE RRP FACILITY - HOW BIG AND WHO
WILL HAVE ACCESS - HUGE QUESTIONS!!! ECONOMICALLY AND
POLITICALLY!
Repos also are an important source of day-to-day funding for banks themselves and
independent broker-dealers, making the repo market the central nervous system for
many of Wall Street’s securities markets.
Traders cite several factors for the dearth of sought-after securities, including a sharp
increase in Treasury holdings by the Federal Reserve after its multiyear stimulus
program; a scramble for U.S. government bonds as yields on European debt have
tumbled; and new rules prompting big banks to reduce holdings of trading securities.
ENLARGE
For example, Goldman Sachs Group Inc.’s repo books contracted 46% last year to
end December at $88 billion, its lowest balance since November 2008, regulatory
filings show. Morgan Stanley’s repo books fell 47% to $95 billion over that period,
and they were down 60% from 2006. SHORTAGE OF SUPPLY - REGULATORS
ARE BREATHING DOWN THEIR NECKS GIVEN ALL THE TOXIC ASSETS
THEY PRODUCED IN PAST - TRIPLE A MY '@*&#'!
The Fed in 2013 began testing a program to alleviate
repo problems by offering an alternative for moneymarket funds and others that couldn’t get repos done
with banks, but the program is capped. THE
PROGRAM IS CAPPED AT $300 BILLION.
EXCERPT FROM SPEECH BY VICE CHAIR
STANLEY FISCHER:
Because not all institutions have access to the IOER rate, we will also use an
overnight reverse repurchase agreement (ON RRP) facility, as needed. In an ON
RRP operation, eligible counterparties may invest funds with the Fed overnight at a
given rate. The ON RRP counterparties include 106 money market funds, 22
broker-dealers, 24 depository institutions, and 12 government-sponsored enterprises,
including several Federal Home Loan Banks, Fannie Mae, Freddie Mac, and
Farmer Mac. This facility should encourage these institutions to be unwilling to lend
to private counterparties in money markets at a rate below that offered on
overnight reverse repos by the Fed. Indeed, testing to date suggests that ON RRP
operations have generally been successful in establishing a soft floor for money
market interest rates (THIS ARTICLE SUGGESTS IT'S NOT SO SUCCESSFUL
AS OF LATE!)
IT SEEMS TO ME THAT THEY SHOULD RAISE THE CAP ON THE RRP
FACILITY????????
The shrinkage in bank repo balances is so acute that interest
rates on repos tied to certain securities have fallen into
negative territory. That means financial institutions such as
banks and money funds are willing to pay up to lend their cash
just so they can have access to specific securities. (NEGATIVE
INTEREST RATES! YOU BUY A HOT DOG (SECURITY)
FOR $9 AND SELL IT BACK THE NEXT DAY FOR $8.90 WHY WOULD YOU BUY THE HOTDOG IN THE FIRST
PLACE?? READ ON!) In late February, the rate on overnight repo loans
secured by two-year U.S. Treasury notes fell below minus-3% on four days in a
single week, according to data from repo brokers, the first reading that negative
since last summer. On Tuesday at quarter-end, the rate on overnight repos backed
by 10-year Treasurys fell to minus-3.5% intraday. Rates on Treasury-backed repos
trading below 0% averaged minus-0.31% last month, versus minus-0.18% a year
ago, said Joseph Abate, money-market-funds analyst at Barclays PLC.
DEMAND ....Firms clamoring for the bonds include banks that are required under
new rules to hold high-quality assets for liquidity purposes, the $2.67 trillion moneymarket-fund industry that is limited to high-quality debt maturing in less than 13
months and hedge funds that require specific securities to settle certain bets and
cannot accept substitutes. SO REGULATIONS ARE FORCING BANKS TO
HOLD 'HIGH QUALITY ASSETS' AND HEDGE FUNDS NEED THEM TO
CLOSE (COVER) THEIR SHORT POSITIONS (NO SUBSTITUTE FOR A
TREASURY!)
Money-market funds take comfort in repos because the trades are secured by bonds.
When they can’t find their first-choice trades in the repo markets, they look to the
next best thing in the open market, dragging down yields on Treasury bills,
commercial paper and other short-term debt. THE SHORTAGE IS RIPPLING
INTO OTHER (SUBSTITUTE) SHORT TERM MARKETS.
“What we are discovering is that even the supposedly most liquid market in the world,
U.S. Treasury debt, is now vulnerable to sudden bouts of volatility,” said Matt King, head
of credit strategy at Citigroup Inc. “This follows very logically from the new
constraints on repo.” AGAIN, BLAME THE REGULATORS
The volatility in Treasurys is reflected in interest rates and supply.
Interest on Treasury bills out to three months is about 0% already, according to data from
Tradeweb Markets LLC. On Tuesday, the bills set to mature out to April 16 briefly
touched intraday lows below zero. In the Oct. 15 Treasury-market “flash crash,” the yield
on the 10-year Treasury note tumbled to its biggest one-day decline since 2009.
The Treasury Department has been cutting issuance of two- and three-year notes so it
didn’t have to reduce bills in high demand, but recently the Treasury has begun to
contemplate increasing its bill issuance, looking for cheaper funding, said a person
familiar with the matter.
The supply of T-bills already has fallen more than $500 billion, or 20%, from their
2009 peak, according to Barclays.
The shortage of certain Treasury notes has caused some firms to miss their scheduled
delivery of collateral in repos. The incidence of trades through primary dealers where
participants failed to deliver Treasurys on time reached 3.6% in the first week of March,
above its 2.5% average over the past year, according to the Federal Reserve Bank of New
York.
The troubles have made it harder, and more expensive, for hedge funds to borrow
specific securities to close out “shorts,” under which they borrow and then sell
securities in a bet the prices will fall.
Chris Tackney, managing director and head of trading at Greylock Capital
Management, which oversees $1 billion, said recently he was unable to borrow as
many emerging-market bonds as he needed for a trade via the repo market. Finding
a specific security can sometimes be so difficult, he said he gives up on such trade
ideas, adding “It’s not even worth our time.” GREYLOCK CAPITAL IS THE
FINANCIAL INTERMEDIARY IN THIS 'TRI-PARTY' REPO.
Some analysts believe that the turbulence in repos could lead to an even greater
demand for government bonds, as investors prize stability in their portfolios.
Fidelity Investments earlier this year said it planned to convert three funds,
including its $111 billion Fidelity Cash Reserves fund, the world’s largest moneymarket fund, to holding government-only bonds, instead of broadly accepted
collateral.
“If you’re a holder of Treasury assets you might be more reluctant to lend them
out,” GOOD AS GOLD! said Natan Magid, a U.S. rates strategist at BMO Capital
Markets.
The amount of Treasurys available to be bought or sold near current prices this
year has fallen 30-40% below its average since 2007, wrote Alex Roever and Jay Barry,
strategists at J.P. Morgan Chase & Co., in a report Thursday.
Write to Katy Burne at [email protected]