The U.S. short-term financing markets and the $2.6 trillion money-fund industry are grappling with one of the most chaotic quarter-end stretches since the financial crisis.
Quarter-end is often a tumultuous period. Banks typically rein in collateral lending as they shore up balance sheets, driving up rates on repurchase agreements. When banks curb repo activity, money funds — the key cash providers in the transactions — need alternative places to invest. In the past few years, one option they've turned to is directing more money into the Federal Reserve's reverse repos, the tool the central bank uses to put a floor under its target for overnight rates.
But this quarter, the movements are out of the ordinary, partly because of the looming Oct. 14 deadline for the overhaul of rules governing money funds. Treasury repo rates have reached the highest since 2008. Meanwhile, the amount of money piling into the Fed's overnight reverse repos surpassed $270 billion, one of the highest levels since officials began testing the program in 2013.
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"It's quarter-end and the money-fund reform all culminating to create more pressure on investors to find places to park cash," said Gennadiy Goldberg, an interest-rate strategist in New York at TD Securities (USA), one of the Fed's 23 primary dealers. The increased use of the Fed's reverse repos "began much earlier, has been harder and faster than prior quarter-ends."
Securities dealers use repos to finance investments and increase leverage. The deals typically involve the lending of Treasuries in exchange for cash, with the debt held as collateral. In general-collateral repos, the lender of funds is willing to accept a variety of eligible securities at a rate that's generally close to the fed funds rate. The Fed effective rate was 0.4% Wednesday.
Yet the general-collateral rate has soared above that. The average level of overnight general-collateral repurchase-agreement rates traded through 10 a.m. New York time Friday with ICAP Plc, the world's largest interdealer broker, was 1.23%, the highest since September 2008.
"Repo-rate increases at these times are due to tighter bank balance sheets and therefore less repo capacity," said Michael Cloherty, head of U.S. interest-rate strategy in New York at primary dealer RBC Capital Markets. "Yet the levels now are consistent with even more intense and more spread-out dealer balance-sheet constraints than other quarter-ends."
There was a similar spike in June that was exacerbated by haven demand for Treasuries after the U.K. vote to leave the European Union, but it dissipated within a few days, as is typical. This time around, the move may be slower to reverse because of the impending deadline for money-fund changes.
New Era
Under the new U.S. Securities and Exchange Commission rules, which are intended to make the money-market industry safer, institutional prime and tax-exempt money funds must abandon the tradition of fixing shares at $1. As a result, money has flooded out of those offerings, with about $650 billion flowing into funds focused on government debt, such as Treasury bills, repo, agency securities and the Fed's reverse repos. The government-fund segment is exempt from the requirement that daily asset values float.
"The money that is leaving prime funds is going directly for the most part into government-only money funds," said Subadra Rajappa, head of U.S. rates strategy in New York at Societe Generale, another primary dealer. "And some of that money, due to quarter-end balance sheet constraints reducing repo, is finding its way to the Fed's overnight RRP program. This does typically happen at quarter-end, but is more exaggerated now due to the fund reform."
The Fed's facility has given money funds a place to park cash when bank repo deals grow scarce and as rates on Treasury bills — another investment option — have slid. One-month bill rates last week touched their lowest this year, at 0.056%, as quarter-end approached. The funds are better off tapping the Fed's reverse-repo program, for which the rate is 0.25%, the bottom of policy makers' target range for overnight borrowing costs.
With more than two weeks to go before the dawn of the new money-fund era, the dislocations sweeping short-term markets may linger.
"Uncertainty about fund flows after the Oct. 14 SEC reform date could keep people invested in the very short-end in bills and the Fed's" reverse repos, said Goldberg at TD.
Bloomberg News
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