Supply Surge Sends Overnight Rates Above 10-Year Yields
July 19 2019 - 5:50PM
Dow Jones News
By Daniel Kruger
The persistent supply of U.S. government debt flooding the bond
market this year has done little to raise bond yields, except in
the market for the shortest-term securities.
The cost to borrow cash overnight has been elevated in part of
the market for repurchase agreements -- or repos -- where lenders
such as money-market funds make short-term loans to bond brokers,
often using government debt as collateral. The overnight rate on
Treasury repos was 2.47% Friday, compared with the 2.35% rate for
interest on excess reserves, or IOER, or 2.048% for 10-year
Treasury notes.
The gap between repo and IOER, which is the interest the Fed
pays to banks that hold excess reserves with the central bank,
exists largely because the rising supply of U.S. government debt
has left bond dealers holding more of it than usual.
The Fed's network of primary dealers, who are required to bid at
government debt auctions, held a total $238 billion of the
securities on July 10. That is roughly $100 billion higher than a
year ago. That has led them to seek ways to benefit from the
holdings, such as lending them in repo trades, analysts said.
That surplus of bonds in the overnight market has forced
bondholders seeking cash to offer higher yields. "It's been quite
welcome," said Deborah Cunningham, who oversees money-market funds
at Federated Investors, who said she frequently holds about half of
her assets in overnight repos.
While investors welcome the extra yield, if it persists it could
become a problem for policy makers. That's because repo trades are
a key component of a new borrowing benchmark designed by the
Federal Reserve Bank of New York. That benchmark, called SOFR, or
the secured overnight financing rate, is the leading replacement
for the fading London interbank offered rate, currently used in
setting interest rates on hundreds of trillions in debt.
Regulators plan to phase out Libor by the end of 2021 following
a rate-fixing scandal which led to billion-dollar fines for several
banks and prison sentences for some traders.
Repo rates are expected to fall should the Fed cut interest
rates as expected at its meeting later this month. Analysts and
investors expect that they will continue to trade at yields that
are higher than other rates set by the Fed, such as IOER. "That
supply story, with rates a little bit elevated, will continue," Ms.
Cunningham said.
While the repo rate could decline to reflect a lower Fed rate,
yields on other securities could fall more because their longer
maturities often reflect expectations for additional cuts in the
future, analysts said.
The supply of securities used for collateral in the repo market
has grown as the Treasury has increased its sales of short-term
debt to help fund rising budget deficits. The government has
auctioned about $1.34 trillion of longer-term notes and bonds
through June, compared with about $2.39 trillion for all of last
year.
"If you have cash, you're definitely being compensated for being
in repo, " said Thomas Simons, a money-market economist at
Jefferies Financial Group. "It would behoove you to continue
concentrating in the short-term because rates are definitely
heading lower."
Write to Daniel Kruger at Daniel.Kruger@wsj.com
(END) Dow Jones Newswires
July 19, 2019 17:35 ET (21:35 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.