The sharp fluctuations in interest rates in the repo market suggest that the sharp decline in funding costs seen earlier this year may be coming to an end.
Funding rates – the cost of holding government bonds – typically rise at the end of a quarter as banks curb lending, but the return of volatility has market participants concerned.
“The days of super-liquidity and depressed short-term markets may be coming to an end,” said Gennady Goldberg, head of U.S. rates strategy at TD Securities. “Liquidity isn’t still in short supply, but the market is no longer drowning in excess liquidity like it was a year ago.”
As a result, market rates have been volatile. On Friday, the general secured repo rate traded around 5.45% before recently hovering around 5.38%. It rose to 5.42% on Wednesday before falling to 4.50%, a 92 basis point swing. This compares with a swing of just a few basis points in the final day of the previous quarter.
While funding markets are far from showing signs of the turmoil experienced late last year and in September 2019, some indicators are beginning to emerge that could signal strains in 2018 and into 2019. Dealer holdings of Treasuries are near record highs and overnight repo rates continue to rise. As a result, overnight rates, and therefore secured overnight funding rates, are taking a long time to normalize after the auction settlement date.
Still, steps are being taken to address potential strains in funding markets. This month, the Fed began slowing the pace of its balance sheet shrinkage, reducing the amount of Treasury securities it rolls over each month, easing the liquidity squeeze.
Additionally, strong backstops have been put in place, such as sponsored repo arrangements that make it easier to access funding sources, with sponsored repo volumes having more than doubled since the 2019 market crash, according to Barclays.
Here are some signs to watch for as the end of the quarter approaches:
Secured Overnight Financing Rates
The Secured Overnight Financing Rate (SOFR) rose to 5.34% as of June 27, according to data released Friday by the Federal Reserve Bank of New York.
The benchmark rate, calculated from transaction-level trilateral repo and cleared bilateral repo data, has started to rise following increases in overnight rates as the quarter-end approaches and is likely to continue to rise following the settlement of the July 1 Treasury coupon auction.
SOFR peaked at 5.35% after the settlement of the May coupon auction on June 3rd and did not return to pre-month levels until the following week.
Reverse Repo Facility
The Fed’s reverse repurchase agreement (RRP) had $664.6 billion in outstanding positions with 93 counterparties as of Friday, the highest number of users since Feb. 21.
These users, mostly money-market mutual funds, park their excess funds in RRPs and earn market interest rates, currently 5.3%. As banks scale back their repo market activities to clean up their balance sheets, money-market mutual funds have typically moved more of their funds into RRPs.
Sponsor Report
Sponsored repo transactions totaled $1.11 trillion as of June 27, according to data from the Japan Securities Depository Center (DTC).
That’s just below the all-time high of $1.124 trillion hit on June 20 as leverage, or demand for borrowing, picked up again in funding markets.Sponsored repo transactions allow lenders to trade with counterparties such as money market funds or hedge funds without running up against the regulatory constraints of their own balance sheets.These contracts are essentially “sponsored,” or cleared, through the Bond Settlement Corp.’s repo platform, allowing dealer banks to offset both sides of the trade and hold less capital against it.
This article has been generated from an automated news agency feed without any modifications to the text.
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