* Low repo rates discourage big securities lenders
* Dealers borrow bonds from Fed to cover short positions
* Repo rates seen rising after this week's bond auctions
By Karen Brettell
NEW YORK, Jan 29 The amount of bonds Wall Street
dealers are borrowing from the U.S. Federal Reserve surged in
the past two weeks due to a scarcity of certain Treasuries
issues in the repurchase agreement market.
The scramble came after large lenders of the securities
moved to the sidelines, as they were being paid less due to a
dramatic drop in yields earned on lending bonds in the repo
Repo rates have plunged in the past month, with rates on
certain Treasuries issues turning negative. This means a firm
would pay interest to lend a Treasury bond, instead of receiving
interest under normal market conditions.
The cost to borrow funds in the $5 trillion repurchase
agreement market against general collateral has plunged since
year-end, dropping from near 30 basis points.
The decline has led securities lenders, who get paid to lend
the bonds, to back away as returns are less attractive. In
response, investors who are short Treasuries are now turning to
the Fed instead to borrow the notes and cover their positions.
"We think that late in the day dealers are using the Fed
more than they have been to cover shorts," said Kenneth
Silliman, head of short-term rates trading at TD Securities in
Dealers can borrow debt from the Fed for themselves or for
clients for 5 basis points, and in return for other bonds being
posted to back the loans.
The wave of shorting in Treasuries manifested in benchmark
yields hitting 2 percent early Monday, which was the highest
level in nine months, before they retreated in late trading.
Investors have been betting that Treasuries yields will rise
in the wake of encouraging U.S. economic data and signs of a
healthier banking system in Europe.
According to a J.P. Morgan survey released on Tuesday, 25
percent of the firm's clients said they held fewer Treasuries
than their portfolio benchmarks, which was the highest level
since July 2011.
Some see repo rates rising by next week, however, as dealers
receive their purchases of new Treasuries supply for sale this
The U.S. Treasury Department is auctioning a combined $99
billion in two-year; five-year and seven-year debt this week.
The amount of notes borrowed from the Fed rose to $21
billion on Monday, the highest level since March, and up from $6
billion on Jan. 17.
Of those notes, three-quarters of notes lent by the Fed on
Monday were in the seven-year sector, maturing from late 2019 to
Analysts attributed much of the demand for seven-year paper
to a scarcity of supply as the U.S. central bank buys bonds as
part of its latest quantitative easing program to stimulate the
"Most of what the Fed lent out yesterday was in the
seven-year sector; the Fed has been buying a lot of that paper,"
said Ira Jersey, an interest rate strategist at Credit Suisse in
Repo rates had risen last year as the Fed sold short-dated
debt as part of its Operation Twist program, in which proceeds
from the sales were used to fund longer-dated bond purchases.
These sales stopped at the end of the year, while investors,
including government money funds, this year have had inflows
and have sought greater investment in the sector.
"You have a ton of cash out there and that cash has to be
put to work," said Jersey.