HEAVY SUPPLY KEEPS US TSY REPOS HIGH; Y2K PULLBACKS WILD CARD
By Ellen Taylor
NEW YORK (MktNews) - Repo rates on current Treasury issues remain fairly high, just below general financing rates, as supplies of 5Y, 10Y, and 30Y notes and bonds continue to weigh down most dealers, traders said.
So much for the widely-expected collateral squeeze that had been expected this month as investment accounts shifted holdings into ultra-safe Treasuries on Y2K liquidity concerns, traders said.
"The biggest story is that everyone expected a collateral squeeze and not a lick of one has surfaced yet," said one repo trader.
For its part, the Fed has tried to counter the potential Y2K liquidity drain by providing backup financing through overnight repo options totalling $481 billion. It's also helped dealers finance a broader array of collateral than it usually takes on, having arranged $42.2 billion in longer repos that roll off between Jan 5 and Feb 9.
The Fed began to accept complicated types of agencies and mortgage securities as well as Treasuries as backing on those transactions, generally charging about 20 bps more for money lent on the more exotic collateral, since October.
The wild card is that late-December pullbacks of collateral linked to expected Y2K disruptions could still result in lower repo rates on both on and off-the-run coupons, traders said.
Both foreign central banks and retail portfolios are expected to withdraw Treasuries they routinely lend on repos during the last week of December, traders said. That could spark a frenzied rush to cover borrowings at a time when most securities lenders will want to be sure they have their securities close to home, traders said.
"If the year-end pullbacks occur, all repo rates will move lower," said Ken Entler, senior vice president at Prudential Securities.
There have been broad concerns that deliveries of both cash and securities will be interrupted by potential computer breakdowns due to the shift to the year 2000 from 1999, they said.
So far, most special repo rates remain within 65 basis points below general financing rates. On Wednesday, the overnight repo rate on the Nov 5y note averaged 5.07%, compared with general repos at about 5.40%. The reopened Aug 10Y note was at 5.19% and the Aug 30Y bond was at 4.73% on average, after being squeezed to a low of 1/4% Monday by dealers who were losing money on longer borrowings of the bond on term reverse repos.
"It was the kiss of death when the Treasury reopened the 10Y note in November," said one trader. The extra supply forced its repo rate sharply higher and is likely to keep it there until Jan 15, another trader said.
The last month of the repo cycle is the time when repo rates are most likely to fall on an issue because most of its supply has already been delivered to retail accounts by then.
That's especially true for the 10Y note which is widely used as a hedge against new supplies in global, corporate and mortgage markets. Accordingly, the 10Y is also the most popular issue used in speculative repo trading. Often its repo slides below 1% on a protracted basis during the last six weeks of its cycle.
The double-old 10Y note issued in Nov 1998 had a repo rate below 2% for most of its cycle which ended in Feb 1999, when the funds target was at 4.75%. Daily repo rates are generally set slightly below funds rates because they are an alternative source of overnight funding available to dealers through their clearing banks.
Traders hold out hope that of all current issues the bond will be the one most likely to trade at lower financing rates soon, since new supplies didn't hit the market in mid-November, as they did with the 5Y and 10Y notes. Another 30Y won't be sold until early February.
On longer repos to Feb. 15, when new bonds will next settle, the 30Y bond is trading at about 2.75% Wednesday. So traders who bought the bond on reverse repos to February over the past week are currently suffering negative carry of about 250 bps, as daily financing costs remain high on the bond, traders said.
"People are intent on moving the bond lower in the overnight market," said Prudential's Entler. "We're at that point in the repo cycle where it's going to move lower or not. So far, it seems it's been good to be short the bond on repos" that mature in February because their rates haven't dropped as much as expected by now.
The 30Y size was $10B when issued on Aug 16. Traders estimate current floating supply available for repos to be about $4 billion.
Repo rates on the bond could also drop suddenly if financing rates rise sharply between Dec 31 and Jan 4, when most Y2K disruptions are expected to occur, traders said. That's because bond supplies, already cut in half by the distribution process, will dwindle more if they are pulled back by portfolios, they said.
"Flows are very light now and will dry up a lot more after Dec. 15," said a repo trader. That could also have a powerful effect on repo rates, he said.
Still, most Y2K problems have yet to surface because the traditional year-end spike in financing costs doesn't usually occur until New Year's Eve. That could be a more costly problem than usual this year since Dec 31 falls on a Friday, magnifying funding costs by a factor of three days.
"Personally I think if there are substantial problems to hit the repo market, they won't occur until the first few days of January," a trader said.
The biggest question facing year-end financiers: Will there be a greater shortage of money or collateral beginning in the last week of December? "It's still early yet and there is a ton of money on the sidelines now. Overseas accounts are also likely to park their money here over year-end because we've got the largest and most secure market," the trader said.
Even so, credit spreads widened to 1999 record levels this week in the commercial paper market, with the gap between borrowing costs for top and second-tier companies over year-end hitting 69 basis points Monday.
"Quality spreads in 30-day CP have surged," said Ray Stone, a managing director at Stone & McCarthy Research Associates in Princeton, N.J. On Monday this spread "was the highest since the Long Term Capital Management debacle. Paper issuance has been strong, and, if it's skewed towards the A2/P2 rating, may be a contributing factor to the spread enlargement. But the overwhelming consideration is clearly Y2K." |
