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Home / Business / Let’s do it again: the turbulent repo market

Let’s do it again: the turbulent repo market



Usually, these transactions are carried out in the background, and there is almost no notoriety. But the system crashes occasionally, just like the end of 2019 and a year ago. This is another moment in those moments.

The 10-year US Treasury bond interest rate on the repurchase market plummeted to minus -4% this week, which is very rare. This means that investors are actually paying the cost of borrowing 10-year bonds, and the opposite is usually the case.

Crowded short betting

As Wall Street economists sharply increased their GDP estimates, investors began to bet heavily that interest rates on government bonds would rise sharply. One way to express this view is to short US Treasuries. (When the price of Treasury bills falls, their interest rates rise.) To make this type of transaction, hedge funds borrow Treasury bills in the repurchase market, sell them and agree to buy them back at a lower price so that they can cash out the difference.
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However, these bets have triggered a strong demand for 10-year US Treasury bonds that can be shorted in the repo market.

Scott Skyrm, executive vice president of fixed income and repurchase business at Curvature Securities, said: “The turbulence is the turbulence in the bond market caused by people’s readjustment of their views on the economy.”

The 10-year U.S. Treasury bond interest rate soared to 1.6% last week, far higher than the low of about 0.3% in March last year.

“Cat and Mouse Game”

Wall Street is essentially testing the Fed, trying to see how high the central bank will allow interest rates to rise before it intervenes.

Mark Cabana, head of interest rate strategy at Bank of America, said: “This is a cat and mouse game.” “The market is challenging the Fed. The Fed is a bit coerced, basically telling the market,’Go solve this problem.’ .”

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But the Fed does not want to harm the economic recovery or frighten Wall Street.

If interest rates rise sharply, this will increase the cost of everything from mortgages and car loans to junk bonds.

As U.S. Treasury bond interest rates soared, the U.S. stock market plummeted last week. Federal Reserve Chairman Jerome Powell commented that the same thing happened on Thursday. Investors were shocked by this. The 10-year U.S. Treasury bond yield climbed above 1.5%. The high yields of ultra-safe government bonds will cause a sensation in high-risk assets such as stocks.

Cabana said: “It will reach a turning point that will have a negative impact on financial markets.”

Overheated debate

However, higher interest rates also indicate that after more than a decade of slow growth and low inflation, the US economy has finally returned to normal.

Former New York Fed Chairman Bill Dudley told CNN Business earlier this week: “They want the economy to overheat.”

Dudley said that the 1.6% interest rate on US Treasury bonds is “not a big deal”, and it is expected that the yield will eventually climb to between 3% and 4% or even higher.

Dudley, who previously served as a senior economist at Goldman Sachs, said: “The bond market now has some unrealistic expectations of the Fed. They certainly want the Fed to stop this.” “And I think the Fed’s view. Yes, no. We will not prevent this. This is normal. This is what happens when the economy looks like it will truly recover.”

Cabana said Dudley has always respected him since he was working with the NY Fed, and he may have taken too many academic methods.

Cabana said: “In terms of stimulating economic growth and achieving full employment, the biggest risk the Fed is trying to achieve is that US interest rates are too high.” “That would tip Apple.”

Federal Reserve Hotel California Issue

When the repurchase market broke out in the fall of 2019, the New York Fed promised to inject billions of dollars into the market, thereby bailing out. The so-called overnight repurchase operation succeeded in calming the market down until the market broke out again during the impact of the pandemic last spring.

The Fed may wish to adopt a laissez-faire approach this time as it tries to gradually exit the crisis mode.

However, Cabana believes that this will not happen, partly because the pandemic has caused a huge federal budget deficit and has made efforts to revitalize the economy.

To make up for the deficit, Washington needs to continue to issue Treasury bonds, and the Fed has been the largest buyer of these bonds. The Federal Reserve buys approximately US$80 billion of US Treasury bonds every month through the quantitative easing (QE) program.
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Cabana said: “The Fed will have to increase its influence in the market. This is how it ends.”

One possibility is that the Fed may further expand its already massive quantitative easing program. Another option is to resume “Operation Twist,” a post-2008 crisis tool designed to curb long-term interest rates.

All of these highlight the difficulty of the Fed’s easing of emergency policies.

Cabana said: “This is the Fed’s problem in California.” “You can check out, but you can never leave.”


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