Rising Repo Rates Fuel Concern Over Mounting U.S. Debt

The cost to borrow cash overnight using Treasurys as collateral has risen, fueling investor concern that bond dealers could become inundated with U.S. debt as the government funds widening budget deficits.

The rate that lenders have charged for cash in the market for Treasury repurchase agreements, or repos, was 2.183% on Monday, compared with the 2.1% that the Federal Reserve pays banks to hold excess reserves. The difference has averaged about 0.2 percentage point since the start of July, twice what it was this year through June.

The elevated repo rate is a sign of the cost of bigger budget deficits, even as yields on 10- and 30-year Treasurys are near record lows. As the government has borrowed more to make up for lower tax revenue stemming from the 2017 corporate tax cuts, bond dealers—who serve as underwriters for the government’s debt—have wound up holding record amounts of Treasurys on their balance sheets.

In the Treasury market, maturities generally range from four weeks to 30 years. When demand from investors rises for Treasurys with fixed interest payments, the prices of those securities rise and their yields fall. In the repo market, when there is a growing supply of bonds that dealers are using as collateral, lenders can charge more for loans.

Although the repo rate has risen by a relatively small amount, it makes some investors and analysts nervous.

The rate charged for cash in the repo market has averaged 0.2 percentage point more than what the Fed pays banks to hold excess reserves.


Photo:

Andrew Harrer/Bloomberg News

“We’re at a time of heightened tensions in the global economy,” which adds to concern about a market at the center of the financial system, said Glenn Havlicek, a former banker who is now chief executive of GLMX. His firm provides technology to repo trading desks, with the aim of making it easier to carry out transactions and report pricing.

“Everybody’s got a toe in the repo market,” Mr. Havlicek said. If there was a problem, “everybody would be affected,” he said.

The potential for risk emanating from the repo market was demonstrated during the financial crisis in 2008. As banks scrambled to maintain access to cash as asset prices fell, some firms inflated the value of their collateral to borrow more. As these borrowers lost access to cash in the repo market, a ripple effect was created, undermining confidence in markets as they became unable to sell or finance their assets.

That scenario is unlikely now. Tighter regulations and structural changes in the market have reduced the chances that higher repo rates will cascade into systemic problems, Mr. Havlicek said.

Still, higher repo rates pose a problem for investors who borrow cash to finance asset purchases because the increase raises their costs. Boosts in repo rates—which tend to occur at the end of months and quarters, when banks try to hold more cash on their balance sheets—are also a concern because they can contribute to surges in volatility across markets.

The rising cost to borrow using repos is significant as the New York Fed, other regulators and big banks shift these funding agreements from an isolated corner of financial markets to a more central role—a move set to affect trillions of dollars of business and consumer debt.

Analysts expect repo rates to rise further because of an upcoming wave of new debt, a result of the two-year budget agreement signed by President Trump earlier this month. That deal is expected to lead to an increase in short-term government bill sales.

Repo rates are also attracting more attention because they are used in setting a short-term reference rate created by the Fed, known as the secured overnight financing rate, or SOFR.

A group of banks and regulators overseen by the New York Fed is pushing for SOFR to replace the discredited London interbank offered rate, a short-term benchmark used in $200 trillion of financial contracts including business loans, mortgages and derivatives.

“Benchmark reform and the integration of SOFR into financial markets makes repo everybody’s problem,” said Joshua Younger, head of U.S. interest-rates derivatives strategy at JPMorgan.

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Write to Daniel Kruger at Daniel.Kruger@wsj.com

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