GC Rates Post Debt Ceiling Crisis
After GC Repo rates spiked during the Debt-Ceiling Crisis in October, rates have declined again. In October, I mentioned how the Debt-Ceiling Crisis would bring collateral back into the market from investor selling, but ultimately, the Fed’s QE purchases would drive rates back down again. And that’s exactly what happened. Rates are trending lower now, and, going forward, I expect overnight GC to trade in a .05% to .08% range between now and year-end. Basically, there’s no reason to expect any upward pressure between now and then.*
Fixed-Rate Reverse-Repo (FRRP)
The Fed increased the FRRP rate floor to 5 basis points in November, which is the maximum allowed by the FOMC. With GC rates trading close to the FRRP each day, cash is moving into the Fed. For much of the program’s history, most of the volume spikes occurred at month-end and quarter-end, but year-end is a whole other story. I expect a significant “window dressing” spike in FRRP volume on December 31.
Rate Band Monetary Policy
As I mentioned last week, there could be a “rate band” monetary policy idea developing for overnight interest rates. The IOER pays banks .25% on excess reserves which sets the upper limit – cash comes out of the Fed and into the Repo market when GC trades in the .25% and .30% range. The FRRP is the 5 basis point lower band, with up to $139 billion in collateral coming into the market courtesy of the Fed. Instead of doing something clumsy, like dropping the IOER to zero or negative, I think a more interesting policy change would be some type of tighter IOER and FRRP rate band. Perhaps something like a 10 basis point band, with a .15% IOER and a .05% FRRP.
The 10 Year note Repo rate plummeted due to a strong short-base in the single-issue Treasury, reminiscent of March and June of this year. Clearly, the 10 year note has more directional shorts, betting on higher rates from “tapering” and increased hedging shorts related to record corporate issuance. 10 Year Repo rates eased up on Monday when the first reopening of the 10 year note settled. If the short-base keeps up, we can expect special 10 Year notes again in late February and early March, the next time there’s a single-issue 10 Year note.
On November 22, Fixed Income Clearing Corp (FICC), the central clearing counterparty (CCP) for the government securities market, asked the SEC to allow RICs (Registered Investment Companies) to join FICC. In one way, this is a major conceptual change in the securities industry because only “dealers” were allowed to be FICC members and allowed access to the inter-dealer market. In another way, it follows the continuing evolution of the market.
RICs will get special advantages from their tier of membership. Though they need to have a minimum of $100 million in assets, they’re not required to participate in the default fund – a trend that’s becoming pretty standard with the “customers” joining CCPs.
Looking a little further in the future, I wonder if FICC is preparing to take on tri-party clearing. I also wonder if this is an open invitation for buy-side participation in the inter-dealer market. Given increased bank regulation and decreased market-making activity, will customers begin to source their liquidity directly from the inter-dealer marketplace?
Governor Daniel Tarullo’s Speech On November 22
Back in August, the FSB in the UK proposed minimum haircuts for securities financing transactions between regulated and non-regulated entities. The suggested haircuts were only for non-sovereign bonds and were about the same as current market levels. The Fed apparently likes the idea and Tarullo suggested three approaches the Fed might take:
- Given that Repo haircuts have increased after the financial crisis, the Fed could establish haircut floors at the current market levels, which will prevent lower haircuts from evolving in the future.
- The Fed could set haircuts based on a formula which is determined by asset price volatility and the largest haircuts which occurred during the financial crisis.
- The Fed could set haircut floors at the regulatory capital requirements for Repo under new regulation. For example, if Basel III requires a capital charge of 2% for a specific Repo trade, then the Fed would require that the 2% haircut be passed on to the customer. For Tarullo, it’s “an indirect way to of extending bank capital requirements to the shadow banking system.” In other words, it’s a way of passing some regulation to hedge funds, investment funds, and other non-regulated entities. It seems to me that the Fed likes this idea.
* GC jumped to .10% on Monday only due to new Treasury settlement