The Big Idea
Some relief for repo
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The Fed decision at its December meeting to start buying more short-term Treasury debt should help address pressure in the repo market seen since mid-October, where SOFR has traded near the top end of the Fed target range and above it in at least three brief episodes. The move should help not only Treasury liquidity, but liquidity in MBS and other assets as well.
Bank reserves have declined this fall, and demand to finance Treasury positions has outstripped overnight cash supply in mid-October and again at the end of October and November. The Fed intent to purchase $40 billion in T-bills starting December 12 and elevated purchases likely through April 15 tax payments should bulk up reserves and relieve some of the pressure.
The New York Fed also announced it will lift its aggregate limit on lending through the Standing Repo Facility, which should also allow more cash to flood the system if repo moves above 3.75%.
SOFR had hovered in the mid-3.90%s before the Fed meeting, just above interest on reserve balances, and tracked IORB down after the meeting to close on December 11 at 3.66%, just a basis point above the reserve rate (Exhibit 1).
Exhibit 1: SOFR tracks IORB lower immediately after the December FOMC
Source: Bloomberg, Santander US Capital Markets
The decision should smooth the operation of repo markets and help keep financing rates for Treasuries within the Fed’s target range. That should also help financing of other assets, particularly agency MBS that usually finances at a spread to SOFR. Liquidity in both Treasuries and MBS should improve, too, since broker-dealers, who typically finance their positions, are less exposed to volatility in financing costs. Primary dealers current finance $473 billion in Treasury positions and $117 billion in MBS (Exhibit 2).
Exhibit 2: Primary dealers currently finance $473 in Treasuries, $117 in MBS
Source: Bloomberg, Santander US Capital Markets
As Stephen Stanley points out, the Fed action also creates a new source of demand for Treasury bills and creates room for the federal government to fund a larger share of its spending on the very front of the yield curve.
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