Barclays Capital’s latest collateral update continues to puzzle over why overnight general collateral (GC) is trading cheap to the overnight indexed swaps (OIS) — a.k.a. the effective Fed funds rate in the US.
Normally, the GC should fetch a lower rate than the unsecured rate. When it’s trading cheap, as above, it means the GC rate is higher than that of the unsecured equivalent.
Joseph Abate at BarCap puts all of this down to technical factors once again — mainly connected to the $200bn of additional supply that’s in the collateral market thanks to the Supplementary Financing Program being activated earlier this year.
This has eased collateral scarcity in the overnight market.
However, this time round, Abate warns of what might happen if the SFP is put on ice. He also suggests the trend is becoming observable in term markets too:
We look for another week of dull trading as investors try to squeeze in additional rounds of golf and family trips before temperatures start falling and school re-opens. In the Treasury repo market, we expect net new supply to remain near recent levels, with little to disrupt the flat trend in repo rates. Of course, one factor that could cause serious disruption would be a decision by the Fed and Treasury to terminate the Supplemental Financing Bill (SFB) program. If, as stated by the Federal Reserve, the central bank is targeting an explicit balance sheet size, then there is little need to keep the $200bn SFB program. Removing $200bn in collateral would likely push repo rates down sharply and drive cash bill yields into the single digits.
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Since June, a curious anomaly has emerged in the repo and unsecured funding markets. General collateral normally trades 4-7bp below fed funds and is now inverted by roughly the same amount. The inversion is also present in term markets. We believe several technical factors account for the role reversal between repo and OIS, including the high level of bank reserves and the absence of trading in the fed funds market. Until the Fed begins draining reserves, our sense is that the OIS market has become somewhat disconnected from other short-term interest rates. As a result, the GC-OIS spread could remain inverted for some time.
In other words, GC may only be trading cheaper to OIS because of the additional supply of bills currently in the market. Remove that from the market, and GC will become far more scarce and expensive — pushing rates sharply down.
The OIS rate, meanwhile, has become largely irrelevant since no-one has an incentive to trade it. They just park their money at the Fed for 0.25 per cent, guaranteed.
Related links:
In the land of two curves, and one price – FT Alphaville
In the land of two-tier rates – FT Alphaville
‘General collateral remains puzzlingly inverted to fed funds’ – FT Alphaville
Euribor has been vaporised – FT Alphaville