Fixed-Rate Repo Update
For all intents and purposes, the Fixed-Rate Reverse-Repo Facility (FRRP) is a hit. Just weeks after its initial launch, the Fed bumped up the counterparty limit from $500 million to $1 billion. With 139 counterparties which are allowed to access the window, it means the Fed increased the total amount of securities they can place into the market to $139 billion. When general collateral Repo rates get down close to 0.0%, that’s an awful lot of Treasurys which can enter the market. But wait, as it turns out, Repo rates don’t need to be close to zero before the market prefers to trade with the Fed. On quarter-end, FRRP counterparties took $58 billion in securities, preferring to have the Fed as a counterparty rather than the Street. Then, during the debt ceiling crisis, there was another blip of higher interest.
Fixed-Rate Repo And Quarter-End
On a typical quarter-end, the spread between general collateral (GC) and fed funds diverges. Depending on the state of the market, GC will trade below fed funds (like in 2009) or above fed funds (like it does now). During 2012, excessive Treasury issuance coupled with the lack of an active QE program meant GC rates were trading well above funds each quarter-end. Since the beginning of the QE3 and QE4 programs, collateral has been removed from the Repo market, reflected in quarter-end financing rates. The FRRP facility was timely for two reasons. First, it prevented GC from dipping into negative rates over the past quarter-end. And second, it served as the new window dressing facility for banks.
So far, the largest single FRRP operation to date was on quarter-end. On September 30, with GC averaging at 10.1 basis points and fed funds at .01%, $58 billion worth of FRRP counterparties preferred to invest their cash at .01% with the Fed than with the Street. Clearly, banks prefer to have a 0% risk weighting counterparty on their books to minimize their capital requirements. Thus, going forward, we can continue to see cash move out of the Repo market and into Fed each quarter-end. The market will be effectively using the Fed for window dressing.
Interestingly, and as expected, interest in the FRRP decreases when GC Repo rates are higher and increases when GC Repo rates are lower. It’s the “substitution effect,” as they say in economics. When the alternative cost to booking trades with the Fed is lower, more cash moves into the Fed. Naturally, structural issues like quarter-end and a debt ceiling crisis are an exception. Right now, I predict, under normal market circumstances, the threshold is about 8 basis points. When GC is about 8 basis points higher than the .01% FRRP rate, cash mostly moves out of the Fed and into the Repo market.
Debt Ceiling Crisis – Update
In what was billed as a last ditch effort to reach a compromise before a pending default, Congress reached a deal to fund the government through January 15 and postpone the debt ceiling issue until February 7. Of course, as in the past, the February 7 deadline is not when a technical default will occur. The Treasury will be able to use “extraordinary measures” to keep the government going longer. According to Wrightson, the Treasury has limited extraordinary measure this time around. They give about a 50-50 chance the government can run though March 12 or 14.* However, if Treasury can somehow make it to April 15, the tax revenues would push the drop-dead date into May or June. In terms of the technical Treasury default, all I can say is “see you next year!”
Debt Ceiling Crisis Debriefing
I want to be clear on my analysis on technical Treasury default and how it was reflected in the markets. Notice, during the crisis, the fed funds rate barely moved. It wasn’t a crisis about bank credit, it was about U.S. Treasurys and Treasury Repo. The 3 month TB rate barely moved too, and when it did, it only moved slightly, reflecting higher 1 month rates. Other than that, there were few default effects on Treasurys maturing longer that 3 months
It was the shortest Treasurys and GC Repo which were affected the most. TBs around 1 month and under were the most likely to have missed a payment. The overnight GC Repo rate was an issue because cash investors were afraid they’d received defaulted Treasurys as collateral and pulled money out of the Repo market. Since the crisis ended, overnight GC and 1 month TBs have moved back to their normal trading ranges.
* “The Money Market Observer”; October 21, 2013; Wrightson ICAP