“We've Never Seen Anything Like This”: Repo Market Snaps As 10Y Suffers “Epic Fail”
It’s been a while since we saw any major dislocations in the Treasury repo market, i.e., collateral shortages as a result of surging TSY shorts, for the simple reason that after the first quarter when everyone was certain that Trump reflation trade would kick in but didn’t, the record number of built up spec net shorts got trampled by the rising price, rapidly shifting over to record longs.
However, the peace and quiet quiet in the repo market was shattered this week, when almost overnight the 10Y went from “normal” in repo, at a rate of 0.50% on Friday, to a special -2.00% on Monday, and then a Super Special, if not record, “fails rate” of -3.50% this morning.
Commenting on this dramatic move in 10Y repo rates, Stone McCarthy’s Alan Chernoff, in a note titled “Epic Fail”, writes that “the 10-year note has been below the fails rate and shows no signs of moving! It opened at -350 basis points, and though pressure has eased off of it slightly, it is STILL below the fails rate at -300 basis points.”
As a reminder, the fails rate is the 300 basis points below the lower end of the target fed funds rate, putting it at -200 basis points currently. And, if an issue falls below the fails rate, it becomes cheaper to just pay the fails charge of 200 basis points rather than deliver than issue, which is what is happening. In dollar terms, the agency repo fails nominal was at $131BN on Sept. 6 vs $153.6 BN on Sept. 5, above the 5-DMA $90.7b, according to DTCC data.
To be sure, some firms that want to maintain good client relationships will likely want to deliver the trade at such a low rate, although it appears that not many are rushing to do so.
As Bloomberg writes, confirming what we have said repeatedly in the past 3 years when we commented on these sudden repo market dislocations, the “specialness is due to lack of supply as shorts roll from triple-issued old 10Y into single issue current 10Y.”
No matter the reason, Chernoff observes that he has never seen a move quite like this and that “this is one of the lowest rates that we’ve ever seen the 10-year note repo trade at, and definitely the furthest below the fails rate.”
One final observations: while even term 10-year repos are below the fails charge at -215 basis points, the 3-year note is only modestly tight at 65 basis points, while and most other issues are trading near GC.
Some final parting words: keep a close eye on the 10Y – a positioning move of this magnitude does not take place in a vacuum, and either “someone knows something” or another busload of specs is about to be crushed once more.