The overnight U.S. repurchase agreement (repo) rate and the secured overnight financing rate (SOFR) recovered from roughly nine-month lows on Friday, but should remain under pressure this year as the market digests excess cash in the system.
In the repo market, Wall Street’s financial institutions borrow from money market funds and other investors and pledge their Treasuries and other securities they own as collateral.
The overnight repo rate rose to 0% on Friday after going negative at -0.05 the previous session, the lowest level since late April last year. SOFR, on the other hand, which also measures the cost of borrowing cash overnight using Treasury securities as collateral, also rose to 0.03%, from 0.01% on Thursday, matching the low hit in May 2020.
SOFR has replaced the London interbank offered rate (LIBOR) as an interest rate benchmark for banks.
The market is dealing with a glut of cash in the financial system with the amount of asset purchases from the Federal Reserve and monetary support from the U.S. Treasury to deal with the coronavirus pandemic.
The U.S. Treasury is also pivoting away from issuing short-term bills and toward longer maturities to finance the fiscal stimulus, which has pressured yields on the front end and weighed on repo rates as well.
“There’s too much cash chasing too few collateral,” said Dan Belton, fixed income strategist at BMO Capital in Chicago. “Treasury has recently been increasing their net coupon issuance while reducing Treasury bills outstanding.”
He added that this week maturing bills exceeded Treasury issuance by $102 billion, a paydown that is “making the cash/collateral problem worse.”
Last week, the U.S. Treasury surprised the market by keeping all of its remaining bill offering sizes unchanged in the first week of the transition to a new pared-down auction schedule.
In other parts of the bond market, spreads on 10-year U.S. interest rate swaps over Treasuries widened a bit on Friday after tightening for two straight days.
Spreads have tightened because investors feared the Fed would move away from its easy monetary policy earlier than expected, pricing in additional Treasury supply to finance the effects of the pandemic, without the Fed buying that debt.
U.S. 10-year swaps measure the cost of exchanging fixed rate cash flows for floating rate ones over a 10-year term.
The spread on 10-year U.S. interest rate swaps over Treasuries was last at 5 basis points on Friday, from the 4.25 basis points on Thursday. Last week that spread hit 9.75 basis points, the widest since April 2020.