Gap Between Fed-Funds, Overnight Treasury Repo Rates Holds
By Katy Burne
A key overnight borrowing rate used across Wall Street still lags behind the policy benchmark the Federal Reserve voted to lift Wednesday by a quarter percentage point, highlighting changing forces at work in short-term interest-rate markets.
On Thursday, when the Federal Reserve Bank of New York raised the policy benchmark into a new range between 0.75% and 1%, rates on overnight Treasury repurchase agreements -- or "repos," short-term loans made in exchange for government debt -- landed at 0.75%, 0.16 point below the effective federal-funds rate of 0.91%.
That relationship is consistent with the gap of 0.15 point between the two rates since the start of the year, according to a Bank of New York Mellon index. It was anticipated because market forces, including an overhaul of U.S. money-market fund rules, have driven up demand for government debt and compressed the rates borrowers pay for lending out Treasurys to get cash.
Analysts have attributed the divergence to investors chasing short-term Treasury bills in particular, amid a scarcity of supply from the U.S. government. Treasury has had fewer bills in circulation than normal because of a long-running standoff in Congress over limits on federal borrowing. The supply of bills outstanding had fallen by $148 billion from the end of November to mid-March, according to Wrightson ICAP.
An agreement between lawmakers struck in late 2015 to suspend the borrowing limit expired Wednesday, putting the debt ceiling back in effect. But the Treasury can still use extraordinary accounting measures, leading many analysts to anticipate an increase in bill supply in the next month that should move Treasury repo rates higher again and narrow the gap between repos and fed funds.
Another reason the Treasury repo rate has been driven lower is healthy demand for a Fed repo program, which is an alternative investment channel for government money-market funds that can't find bills to buy with their cash. In the Fed program, the central bank lends out Treasurys from its $4.5 trillion balance sheet as collateral in exchange for sucking up excess cash from money-market funds, so as to keep short-term rates in its desired range.
The BNY index factors in those Treasury-backed repo transactions with the Fed, which as of Thursday paid participants a rate of 0.75%, unlike other indexes that don't include the trades. The Fed's repo rate is designed to set a floor under the central bank's range while another tool sets the ceiling, leaving the federal-funds rate to float in between.
A fed-funds rate of 0.91% is still seen as accommodative by Fed officials. The Fed has signaled that rate increases should continue gradually, not as aggressively as some in the market anticipated. Before this week, the Fed had raised rates only twice, in December 2015 and December 2016, since 2006.
"Rates are just getting closer to neutral, which is appropriate and arguably should have been done last year," said John Vail, chief global strategist at Nikko Asset Management, which oversees about $165 billion and is owned by Sumitomo Mitsui Trust Bank.
Write to Katy Burne at [email protected]