March 20, 2012 / 7:37 PM / 6 years ago

Higher repo rates cool demand at 4-week T-bill auctions

NEW YORK (Reuters) - A $40 billion Treasury sale of four-week bills drew the most tepid bidding in just over a month on Tuesday as better rates available in the repo market damped demand for bills offering less attractive returns.

The value of bids offered over those accepted at this week’s bill auction was 3.99, the lowest since February 14.

Dealers’ bid was $2 billion smaller than a week earlier, yet they captured a portion of the sale that was $2 billion larger than last week’s and amounted to 73.2 percent of the bills sold. Direct bidders took 10.9 percent of the bills, toward the lower end of the recent range.

“With repo rates ranging from the low teens to mid-20s, demand for 4-week bills yielding 10 basis points or less has been weak,” said Thomas Simons, vice president and money market economist at Jefferies & Co in New York.

Only investors who have to adjust the average duration of their portfolios “are participating in the auctions,” he said.


Overnight Treasury repo rates have cheapened steadily all month and by late last week, the collateral had cheapened to more than 20 basis points and the repo rate was at its highest level since last summer’s debt-ceiling crisis.

“Besides the temporary balance-sheet distortion at quarter-end, which will push repo rates lower, we expect collateral rates to stick near current levels until mid-April,” said Barclays Capital market analyst Joseph Abate in New York.

Abate said supply appeared to be driving that trend.

Dealers’ inventories of short coupons and bills climbed to over $80 billion in the first week of March, and dealers have also held “a respectably sized” long position in Treasuries maturing in more than 11 years, he said.

Dealers’ only short position is in the intermediate sector with Treasuries maturing in six to 11 years.

Abate said the “pile-up” of Treasuries on dealer balance sheets is linked to the Federal Reserve’s “Operation Twist” transactions in which the Treasury sells shorter-dated maturities on its balance sheet and uses the proceeds to buy longer-dated Treasuries to keep long-term interest rates low.

“It takes time for dealers to re-distribute the short-dated paper to final buyers and meanwhile, the dealers need to finance these holdings in the repo market,” Abate said.

The normal seasonal rise in bill supply has also contributed to higher repo rates, analysts said.

That factor should start to fade once the April 17 deadline for U.S. tax returns has passed.

As revenues arrive from taxpayers, the Treasury’s need to raise short-term cash will decline and so will bill supply.

The Treasury Borrowing Advisory Committee expects bill supply to contract by $120 billion in the second quarter.

“With (the Fed‘s) Operation Twist sales continuing through the end of June, we look for repo rates to remain heavy - but closer to 15 basis points,” Abate said.

One element of uncertainty is whether government-sponsored enterprises (GSEs) will soon return to the repo market.

“Since July 2011, GSEs have been leaving sizable balances in their deposit account at the Federal Reserve uninvested - generally over $40 billion, but in some weeks much more than that,” Abate said.

Since these balances are unremunerated, the GSEs have an incentive to invest their cash in the repo, bill, and to a much smaller extent, the (shrunken) fed funds market, he said.

When repo rates were under 10 basis points last year, the reward for investing in these markets were probably too small to persuade the GSEs to accept counterparty risk instead of leaving their cash safely at the Fed, Abate said.

“But now that overnight collateral has cheapened to 20 basis points, the incentive for GSEs to invest in the repo, bill and fed funds markets may be stronger,” he said.

“If GSEs reduce their balance at the Fed and push their cash into the repo market, collateral rates could richen,” Abate said.

Editing by Jan Paschal

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