Rates in the US funding market surged at the end of the quarter in a sign of potentially further dislocations in money markets as Congress lifts the debt ceiling.
Volatility intensified on Monday beyond the typical spikes seen at the end of months and quarters. That’s fueled concern among some market participants about dysfunctions in the plumbing of the US financial system and the ability of the market to absorb the deluge of bills once the debt ceiling is resolved.
Now, with the president’s tax bill making its way through Congress, that test seems all the more imminent, with some predicting the onslaught of issuance will begin as early as this month.
“If signed into law by Friday then issuance comes right after,” said TD Securities strategist Jan Nevruzi. “For funding markets, I think that implies a more gradual drift higher in repo rates rather than the impact showing up immediately.”
Typically, at month- and quarter-end funding costs rise as banks shore up their balance sheets for regulatory purposes by reining in activity in the market for repurchase agreements. But on Monday, the Secured Overnight Financing Rate — an important one-day lending benchmark linked to activity in the market for overnight repurchase agreements collateralized by US Treasuries — climbed to 4.45%, the highest this year.
“The situation does warrant keeping an eye on,” John Velis, a foreign-exchange and macro strategist at BNY, wrote in a note to clients on Tuesday. Resolution of the debt ceiling could inject additional stresses into money markets and “repo rates will likely be higher and more sensitive in this case,” he said.
Meanwhile, sponsored repo transactions, a corner of the market that allows lenders to avoid regulatory constraints, hit a record high and demand surged for Federal Reserve facilities, such as the Standing Repo Facility (SRF) and the overnight reverse repo facility (RRP), that backstop funding markets.
All this has market watchers on alert. That’s because as money has shifted out of the Treasury’s account at the Fed, it’s been artificially boosting liquidity in the financial system and masking signals needed to gauge the amount of stress lurking in markets. Yet once the debt limit is lifted, this abundance of cash is expected to quickly reverse, increasing risks of more disruption in overnight markets, even motivating counterparties to make greater use of the central bank’s repo facility.
Here are a few of the key funding-market metrics to monitor:
Repo Spreads
The spread between the 75th and 25th percentiles of the Secured Overnight Financing Rate — a preferred proxy for dealer bid-offer funding spreads — widened to 12 basis points as of June 30, the biggest gap since year end, reflecting increased costs for dealers to intermediate in the funding markets at the end of the quarter.
Sponsored Repo
Sponsored repo activity totaled $2.45 trillion as of June 30, Depository Trust and Clearing Corp. data show. That surpassed the previous all-time high of $2.20 trillion reached on June 27 as dealer constraints drove more activity to this part of the repo market. The roughly $251 billion daily increase in volumes was the largest since sponsored repo became available in 2019.
Sponsored repo transactions allow lenders to transact with counterparties like money-market funds and hedge funds, without bumping up against regulatory constraints of their own balance sheets. These agreements are effectively “sponsored” or cleared via the Fixed Income Clearing Corp.’s repo platform, thereby allowing dealer-banks to net two sides of a trade and hold less capital against it.
Standing Repo Facility
The Fed’s Standing Repo Facility allows eligible institutions to borrow cash in exchange for Treasury and agency debt at a rate in line with the top of the Fed’s policy target range — currently 4.5%. This is meant to help put a ceiling on repo rates, though there have been questions about whether it does so during moments of market stress.
Counterparties tapped the SRF for a total of $11.075 billion on Monday, the most since June 2020, though at the time the daily operations were still temporary. Usage is the biggest since the SRF was made permanent in July 2021. Participants tapped the facility for $5.075 billion at the morning operation and another $6 billion at the afternoon offering.
Reverse Repo Facility
The lack of dealer balance-sheet capacity tends to push any excess cash back to the Fed’s overnight reverse repo facility. Usage of the RRP surged by roughly $175 billion on the final trading session of June to about $461 billion, the biggest since Dec. 31. Wrightson ICAP expects that to reverse on Tuesday, with the total falling to around $250 billion.
Written by: Alex Harris @Bloomberg
The post “Volatile Quarter-End Signals Funding-Market Dysfunction to Come” first appeared on Bloomberg