Collateral Shortage History
Every year, well almost every year, Repo rates decline from the middle of April to around the middle of May. This has come to be known as the “April Collateral Shortage” or “Seasonal April Collateral Shortage” or something like that. The collateral shortage is best described as a relative decline in Repo rates since it’s literally a shortage in overnight general collateral and not in a decline in all short-term rates. It occurs when a large amount of Treasury bills mature right after the April 15 tax date, that loss of short-term bills creates a shortage of collateral in the Repo market. Not only are there fewer Treasury securities, but much of the money that was invested in those bills is freed up and moves into the Repo market. This is the main cause of the seasonal collateral shortage and it’s directly related to “tax season” each year.
Traders first started noticing the collateral shortage after April 1997, that was the first year the U.S. government ran a budget surplus and tax receipts were abnormally high that April. For the last two weeks of April 1997, general collateral (GC) averaged 12.8 basis points below fed funds. Before that, the most significant April collateral shortage occurred in 1990, when a massive (!) $26.9 billion bills matured mid-month. Obviously things have changed a lot since then, swings of $26.9 billion in Treasury issuance and maturities happen quite frequently now.
There isn’t a collateral shortage every April, but it’s still is a fairly regular occurrence. The most severe shortages pushed GC to average 21.3 basis points* below funds in 2000, 20.3 basis points below funds in 2008, and 18 basis points below funds in 2001. In general, the collateral shortage can be expect to begin on April 15, or when the first Cash Management Bills (CMBs) mature, and last until the middle of May, usually May 15. However, some years the shortage ended as soon as April 29 (2005), as late as June 1 (2006), and once it even stretched as far as July 17 in 2000.
These days it takes much larger numbers to move overnight rates. A change of $26.9 billion today is only worth one or two days of a fed funds pressure or soft funding. In 2007, the amount of bill collateral maturing was $89.8 billion and it created a premium for Treasury GC of 13.3 basis points below fed funds. In 2004, the maturing amount was $69 billion and that only moved GC to 7 basis points below fed funds. Large bill maturities don’t necessarily translate into guaranteed shortages. Whereas back in 1999 there was $101 billion in regular bills and CMBs maturing, it resulted in virtually no collateral shortage, GC averaged only 3.3 basis points below funds that season. Obviously, there are other factors at work.
The Reasons Why – The Technicals
Just like in many markets, the collateral shortage is a function of supply and demand. There are two factors that naturally compete in the Repo market, the supply and demand for collateral, and the supply and demand for cash. For the April collateral shortage, it’s effectively a double whammy – there’s a decrease in the supply of collateral (fewer Treasury bills) and there’s also more cash at the Treasury.
In anticipation of the tax revenue arriving on April 15, the Treasury begins to increase the size of its Treasury bill auctions, both CMBs and regular bills, beginning in February. They need to borrow additional funds to make it through the April 15 tax date, but once the tax receipts start coming in, the Treasury no longer needs to borrow as much, at least for a while. The CM bills generally mature a few days after April 15 and, as those bills mature, more and more cash goes into the Repo market. This is what creates the shortage on the collateral side – a large amount of short-term bills mature over short period of time.
On the cash side of the equation, as the Treasury collects tax revenue it goes into the Treasury Tax and Loan accounts (TT&L) accounts. That rising Treasury cash balances create more cash in the system looking for short-term investments, which again, pushes more cash into the Repo market.
Factors That Increase The Shortage
The size and depth of the collateral shortage would be easy to predict if the size of the bill maturities were the only factor. Given the Repo market is so large, with many moving parts, there are several other factors which play a role in the size and depth of the shortage.
- Quantitative Easing Programs – The Fed’s QE purchases are a factor. If the Fed is taking collateral out of the market it means there is a declining supply of Treasury collateral anyway. This added to the depth of the shortage in 2011 and may be a factor this year.
- Flight-To-Quality – If the market is experiencing a “flight-to-quality,” it means there’s already a shortage of treasury collateral before the seasonal April factors begin. This was the case in March 2008 after Bear Stearns collapsed and it led to a severe collateral shortage in April that year (see below).
- General Money Flows – Depending on the sentiment in the market, investors will allocate more or less of their investments to cash. This was a factor which has extended to shortage well into May. Back in 2000, much of the market was waiting for Fed to tighten at the May 2000 FOMC meeting. Investors were holding off investment decisions until after the Fed meeting, which meant more cash remained on the sidelines and thus, more cash remained in the Repo market. There was a similar situation in 2006, where investors were sitting on cash and waiting for the outcome of May FOMC meeting.
- Treasury Issuance – If anyone can still believe it, the U.S. government once ran a budget surplus. From 1997 to 2001 there was “surplus revenue” going into the Treasury’s coffers and that meant they were issuing fewer Treasury securities, so when the bills matured in April the collateral shortage was more severe.
Factors That Decrease The Shortage
- Treasury Issuance – Just as the Treasury can be paying down debt, they can also be issuing more debt. Beginning in 2009, there was a massive increase in the Treasury’s debt issuance, which partially offset the losses of the maturing bills, resulting in milder April collateral shortages.
- Issuance Calendar – There is a natural mechanism in place to minimize the effects of the shortage – the regular issuance calendar of the Treasury. When there is a shortage, the Treasury is always scheduled to settle more bills on Thursdays, new 2 year notes, 5 year notes, and 7 year notes at the end of month and the quarterly refunding settling on May 15.
- Event Reset – Many times in the Repo market, it takes some other funding event to reset distortions. Where there is no rational why something like month-end would end the collateral shortage, outside of the factors listed above, there is a tendency for distortions to correct after an event like a month-end, quarter-end or quarterly refunding settlement. There’s no real rational, but it happens.
The effects of the collateral shortage have not been severe in recent years. In 2009, 2010, and 2012 there were no significant collateral shortages. During these years, April 2011 was the only year that had a high premium for Treasury securities during the collateral shortage season. Why? Simple. QE2 was already taking about $100 billion in Treasurys out of the market each month, the additional bills maturating in April pushed GC rates even lower.
Expectations for April 2013
That brings us to this year. Right now, there are $115 billion CMBs maturing on April 15, April 18 and April 25, which is much larger than normal and certainly large enough to create a significant Treasury collateral premium in the market. In addition, the Fed has two QE programs going strong, QE3 (buying agency MBS, which does not have a direct effect on Treasury collateral) and the QE4 program purchasing Treasurys. Though the Treasury QE4 purchases are smaller than 2011, they will obviously be a factor this year. Then, there is a wildcard that just went into play last week – The Sequester. Between now and the end of the fiscal year in September, the U.S. government is forced to spend $85 billion less and that will decrease new Treasury issuance – another factor that could contribute to the collateral shortage. However, there is a chance of a budget deal which will then resume normal issuance again. As I said, it’s a wildcard.
Now, given the January mini-collateral shortage was still going strong into February and was only reversed by large bill issuance at the end of February, it means that after April 15, many of those bills are maturing – disappearing from the market. My early call for GC for the last two weeks of April is a range between .10% and .05%, with fed funds trading around .15%, generating a GC/fed funds spread around -8.
* April 15 to May 15