(Chart via RBC.)
There’s a normal seasonal rise in Treasury bill supply at this time of year, usually lasting through to about April, but it typically doesn’t produce such a large upward push on General Collateral repo rates.
And among the reasons for the market’s greater sensitivity to the increasing supply this year has to do with the Fed’s commitment to keep rates low through at least 2014, announced at the last FOMC meeting. According to the rates squad at RBC:
First, assets held by Treasury-only money market funds have declined after surging in 2008 and 2009. The smaller captive investor base makes the market somewhat less able to handle swings in supply.
Second, the late-2014 language by the Fed has encouraged investors to take leveraged positions in Treasuries, buying short-to-intermediate Treasuries and financing them overnight. That greater supply of collateral should put some upward pressure on overnight financing rates.
Third, while money market funds have started to increase their exposure to European banks somewhat, the levels remain depressed. Any of these entities that are members of the GSCC still have access to a massive amount of financing for their Treasuries, as they can lend their collateral to the clearinghouse, and another dealer can borrow that collateral and relend it to a money market fund (for a slight spread). Unfortunately, this transaction inflates the balance sheet of the dealer that is acting as a conduit, which means that dealer is less prepared to absorb any seasonal increase in supply.
The points about money market funds and their effects on repo markets as they struggle with their business models and an uncertain regulatory future were well known.
And when we wrote about the potential impact of the Fed’s low-rate commitment on US banks, we mentioned that eventually repo rates could rise quickly once the Fed finally signals its intention to start tightening — the consequence of both large reverse repos by the Fed and the spike in supply from asset sales. And it might even have a paradoxical inflationary effect that you wouldn’t expect during a time of tightening.
But all that’s a long way off, and we hadn’t realised it would have any noticeable impact on repo, even a slight one, this soon.
Related links:
Banking off the FOMC – FT Alphaville
The QE exit-inflation paradox – FT Alphaville
The flight and plight of US money market funds – FT Alphaville