The Days of ‘Sleepy’ Funding Markets at Quarter-End Are Over

The whipsawing of rates in the market for repurchase agreements suggests that the collapse in funding costs seen earlier in the year has come to an end.

Funding rates — the cost of financing holdings of Treasuries — typically march higher at the end of the quarter as banks rein in lending. But the return of volatility is on the radar of market participants.

“The days of ultra-high liquidity and sleepy front-end markets may be coming to an end,” said Gennadiy Goldberg, head of US interest rate strategy at TD Securities. “Liquidity is still far from scarce, but markets are no longer drowning in excess liquidity like they were just a year ago.” 

That’s left market rates gyrating. On Friday, the rate on general collateral repo was recently around 5.38% after first trading around 5.45%. The was as high as 5.42% on Wednesday before dropping to 4.50%, a 92 basis point swing. That compares with moves of just a few basis points in the final days of last quarter.

While funding markets are far from showing signs of the turmoil seen late last year and even that experienced in September 2019, several indicators that warned of strains in 2018-2019 have started to appear. Dealer holdings of Treasuries are near all-time highs and overnight repo rates continue to creep up. As a result, it has taken overnight rates — and by extension the Secured Overnight Financing Rate — longer to normalize after auction settlement days. 

Still, steps have been taken to address potential strains in funding markets. This month, the Federal Reserve started shrinking its balance sheet at a slower pace, reducing the amount of Treasuries it lets roll off every month, thereby easing a drain on liquidity. 

In addition, stronger backstops such as sponsored repo, which allows easier access to funding sources, are in place, according to Barclays Plc. Volumes in sponsored repo have more than doubled since the market blowujp in 2019. 

Here’s what to watch for signs of funding strains as the quarter draws to a close: 

Secured Overnight Financing Rate

The Secured Overnight Financing Rate, or SOFR, rose to 5.34% as of June 27, according to Federal Reserve Bank of New York data published Friday. 

The reference rate, which is calculated from transaction-level tri-party repo and cleared bilateral repo data, has started climbing in response to the rise in overnight rates as the end of the quarter approaches, and could continue to climb in response to Treasury coupon auction settlements on July 1.

SOFR peaked at 5.35% after May’s coupon auction settlements on June 3 and didn’t return to pre-month end levels until the following week. 

The Fed’s reverse repo facility, or RRP, houses $664.6 billion as of Friday with 93 counterparties. That’s the most to use the tool since Feb. 21. 

Those users — mostly money-market mutual funds — park excess cash in the RRP to earn a market rate, currently 5.3%. As banks pare their repo market activity to tidy up their balance sheets, money funds typically shift more cash to the RRP. 

Sponsored repo activity totaled $1.11 trillion as of June 27, Depository Trust and Clearing Corp. data show. 

That’s just off the all-time high $1.124 trillion reached on June 20 as demand for leverage, or borrowing, in the funding market ramps up again. 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. 

This article was generated from an automated news agency feed without modifications to text.

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