The cost of borrowing U.S. 10-year Treasuries in the overnight repurchase, or repo market, went deeply negative on Thursday, analysts said, as investors sought to short the notes, causing market stress.
Negative rates in the repo market, which is important to the financial system, with trillions of dollars in short-term loans traded daily, partly reflect uncertainty about how long the U.S. Federal Reserve will keep its easy monetary policy.
“There is more market stress right now because the market is very volatile,” said Scott Skyrm, executive vice president at broker-dealer Curvature Securities.
The negative cost-to-borrow came as investors were shorting the notes in a bet that U.S. Treasury yields would continue to rise, on expectations of increased issuance to finance the U.S. stimulus package and on optimism on prospects of a recovery as the country emerges from the coronavirus pandemic.
That has boosted short positions on the benchmark U.S. Treasury note which last yielded 1.578%.
The 10-year cost to borrow repo rate, which is typically positive, has been negative since Monday and hit as low as -4.25% on Thursday, analysts said. It was last at -0.50% as the Federal stepped in on Thursday to sell U.S. 10-year Treasuries in the market. The last time U.S. 10-year repo rates went negative before this week was June 2020 and before that in March of the same year, Skyrm said.
The general collateral rate, however, remained above zero on Thursday at 0.05%, after dipping negative last week at -0.05 basis points.
The repo market sees Wall Street’s financial institutions borrow from money market funds and other investors and pledge their Treasuries and other securities they own as collateral. Lenders in repo markets typically include money market funds, insurance companies, corporations, municipalities, central banks and commercial banks that have excess cash to invest.
Negative repo rates typically occur when a particular collateral security becomes in demand – in this case analysts pointed to the 10-year Treasury – or there is a reduced supply in the repo market.
In order to borrow these securities, buyers have to tempt potential sellers with cheap cash or a repo rate that is less than the general collateral repo rate.
On the other hand, dealers and depository institutions borrow cash against long positions in securities to finance their net inventory and balance sheet position.
“There’s general pressure on rates at the short end, the same themes that have been in place for a while,” said Tom Simons, money market economist at Jefferies.
“Supply is falling – we’re having bill redemptions every couple of days here on the order of $25-$30 billion.”
Gennadiy Goldberg, senior rates strategist at TD Securities, said dealer positions in off-the-run, or older securities, have grown sharply with the selloff in Treasuries that pushed yields higher. Dealers have attempted to hedge this risk by selling on-the-run or newer securities.
“This has driven the cost of borrowing on-the-run Treasuries sharply lower and past the fail rate which is the penalty rate market participants pay if they cannot deliver a security,” he added.
That so-called fail rate is -3%, Goldberg said.
Some investors also turned to the Fed to obtain collateral on Thursday, with its reverse repo operation seeing $2.1 billion in demand, up from half a billion on Wednesday. Demand in the facility increased last week as Treasury volatility increased, peaking at $11.2 billion on Friday.
Skyrm said the Fed loaned $8.7 billion of its $10.9 billion holdings of U.S. 10-year notes on Thursday, easing the debt squeeze.
Analysts also said dealers are also preparing for next week’s U.S. Treasury auction with the $38 billion sale of reopened U.S. 10-year notes, especially in the wake of last week’s poor auction of 7-year notes.