Dynamic market changes and positioning have impacted the repo market for U.S. Treasuries.
Over recent weeks and months, the markets have largely focused on inflation, the debt ceiling debate, and potential changes in FOMC policy. This seems to have built up a short base in certain parts of the treasury coupon curve that is causing dislocations. Interestingly, the Federal Reserve Bank of New York has become more active in the market by lending specific securities.
The connection between the Treasury market, repo and market participants is more important than ever across a range of trading products. This includes the Secured Overnight Financing Rate (SOFR), the successor to LIBOR, and is unpinned by almost a trillion dollars of repo transactions.
Understanding some of these technical drivers of repo specials can be beneficial.
To express a short Treasury view, a trader needs to first borrow a Treasury security and then sell it. If the price of the security falls more than the price of the purchase and associated financing cost, the strategy can be profitable. For a variety of technical reasons, the market may prefer to short a particular Treasury coupon. This can lead to localized supply and demand imbalances for a particular Treasury issuance that is reflected in repo pricing.
If the market changes suddenly, the security may become dearer to investors. When a particular issue is in high demand, it is considered special and is defined as having a financing rate of less than that of general collateral (GC). On Oct. 13, Bloomberg reported that GC traded to 0.01% or 1 basis point (bp), and many Treasuries traded below that level with the two-year the notable standout at -5bps.
The Fed Gets Involved
Another supply of Treasury securities that primary dealers can tap into is the Federal Reserve Bank of New York. The bank holds nearly $5.5 trillion of U.S. Treasuries in its System Open Market Account (SOMA) across a range of different Treasury securities.
To help provide access to these liquid securities, the Bank uses the SOMA Lending Program, a voluntary lending program for primary dealers in which the dealer provides an interest rate level they are willing to pay in order to borrow a specific security.
The bid rate represents the lending fee rate that a participant is willing to pay in order to borrow the security. It is not a repo rate. Because the program operates on a borrow-versus-pledge basis, the bid rate may be considered equivalent to the spread between the general collateral rate and the specials rate for the borrowed security.
The bank reports on its Security Lending Operations daily. The Oct. 13 report showed that the Federal Reserve Bank of New York lent out nearly $5 billion of the September 2024, 3/8% coupon and earned 42 basis points while most of the rest of the curve was earning 5 basis points.
This security is part of the delivery basket for 3-Year T-Note futures. Looking at the Oct. 6 report of SOMA holding, the bank held just over $6 billion, or less than 10% of the outstanding amount of the issue. The market is looking closely not only at this security, but also across the curve.
SOFR Market Solid, but with Lower Range
While the Specials market has witnessed some interesting moves, the SOFR rate has remained stable at 5 bps as it has over the prior month and longer. In fact, SOFR has traded 5 bps since June 17, 2021, when the Federal Reserve Bank of NY raised the reverse repo rate. Prior to that, it traded at 1 basis point. SOFR volumes have remained around $900 billion.
Of note, the calculated 1st percentile, or lower end, of the rate distribution traded -1bp over the prior two days. This is not uncommon at month end, but this is a newer development during the month of October.
Isn’t That Special?
The markets, the Federal Reserve and many trading products are more connected with the repo market than ever. Keeping an eye on these developments will be important to appreciate some interesting supply and demand characteristics and potential influences on other areas.
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