By Gertrude Chavez-Dreyfuss
NEW YORK, Dec 17 (Reuters) – The U.S. bond market is heading into the year-end with less anxiety than usual, sanguine that the Federal Reserve’s latest funding plans will cushion the seasonal cash crunch that occurs as banks pull back from short-term lending.
Short-term money market rates typically spike at the “turn” of each quarter and year as banks withhold lending and conserve cash to better manage their capital and shore up balance sheets.
Rates on repurchase agreements, or repos, which allow hedge funds and banks to borrow money cheaply using Treasuries and other debt securities as collateral, were higher than average in 2023, and volatile in the final days of 2024.
In September 2019, there was a big spike in repo rates due to a large drop in bank reserves as corporations tried to meet a tax deadline and make payments for debt settlements.
But market pricing for repos at the turn of this year – the period from December 31 to January 2 – has turned sharply lower after the Fed said last week it will purchase short-dated Treasury bills to help manage cash levels and ensure that it retains control over its interest rate target range.
Such Fed buying, also called reserve management purchases (RMPs), will total around $40 billion in Treasury bills per month over the near term.
“The Fed wants to be able to maintain overnight rates without spikes during tax days or year-end,” said Bob Savage, head of markets macro strategy, at BNY in New York.
“So I don’t see a massive move on December 31 that gets people’s focus like in 2019. I think the Fed has the right tools.”
The Fed’s latest measure was announced at the conclusion of its policy meeting last week when it reduced the benchmark rate by 25 basis points to a target range of 3.50%-3.75%.
The $40 billion bills purchase is on top of the $15 billion that the Fed will be reinvesting in T-bills from the proceeds of its maturing mortgage-backed securities (MBS), a move announced by the U.S. central bank at the October meeting.
Those purchases by the Fed should provide relief to funding pressures typically seen over the year-end, analysts said.
The Fed’s increased buying of Treasury bills should also significantly reduce the amounts private investors buy in 2026, possibly driving bill prices higher and yields lower. This should help reduce debt supply pressures that have caused repo rates to spike, analysts said.
YEAR-END “TURN” FALLS
The general collateral repo rate for the year-end “turn” fell last Friday to 4.10%, from 4.25% two weeks earlier, analysts said. That is still about 46 basis points above the fed funds rate, currently at 3.64%.
“Sometimes the psychology of actually seeing lower rates helps, but the Fed’s commitment to buy Treasury bills also helped,” said Scott Skyrm, executive vice president at Curvature Securities in New York.
“There’s a lot more collateral and volatility in the repo market this year so a wider spread at this date is fair. I believe the spread will narrow as we move closer to the end of the month.”
Money markets have been fickle during turns. The intraday repo rates hit 10% in September 2019, forcing the Fed to inject hundreds of billions of dollars through daily operations to bring them down closer to the policy rate of 1.55% by the end of that year.
In 2020 and 2021, year-end repo rates stayed below 1% as the Fed maintained an easing bias during the pandemic.
The repo rate was only about 20 basis points above the average level for the year at the end of 2023, whereas in 2024, overnight funding costs swung from 50 basis points above the Fed funds rate to as low as 40 basis points below the year’s average by the last day.
This year’s decline in repo rates for the year-end suggests cash conditions are improving and that market participants anticipate less strain on balance sheets compared to prior years.
The general collateral repo rate on Tuesday, however, was at 3.72%, a little higher than the Interest Rate on Reserve Balances (IORB) of 3.65%. That has been a persistent concern for the Fed. High overnight rates – above the IORB – increase banks’ motivation to lend their cash in the repo market instead of holding it as reserves at the Fed.
In general, more bank reserves mean less funding stress, and suggest that financial firms have ample cash to meet payments, margin calls, and withdrawals.
“So far, I think repo markets are still orderly even if price action is still trading at an elevated range,” said Teresa Ho, head of short-duration strategy at J.P. Morgan in Boston.
“We’re also seeing just more activity in terms of people trying to prepare over the year-end. So the more people prepare for it, the more the year-end becomes a non-event.”
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Vidya Ranganathan and Andrea Ricci )
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