Supply Surge Sends Overnight Rates Above 10-Year Yields

The persistent supply of U.S. government debt flooding the bond market this year has done little to raise bond yields, except in the market for the shortest-term securities.

The cost to borrow cash overnight has been elevated in part of the market for repurchase agreements—or repos—where lenders such as money-market funds make short-term loans to bond brokers, often using government debt as collateral. The overnight rate on Treasury repos was 2.47% Friday, compared with the 2.35% rate for interest on excess reserves, or IOER, or 2.048% for 10-year Treasury notes.

The gap between repo and IOER, which is the interest the Fed pays to banks that hold excess reserves with the central bank, exists largely because the rising supply of U.S. government debt has left bond dealers holding more of it than usual.

The Fed’s network of primary dealers, who are required to bid at government debt auctions, held a total $238 billion of the securities on July 10. That is roughly $100 billion higher than a year ago. That has led them to seek ways to benefit from the holdings, such as lending them in repo trades, analysts said.

That surplus of bonds in the overnight market has forced bondholders seeking cash to offer higher yields. “It’s been quite welcome,” said Deborah Cunningham, who oversees money-market funds at Federated Investors. She said she frequently holds about half of her assets in overnight repos.

While investors welcome the extra yield, if it persists it could become a problem for policy makers. That’s because repo trades are a key component of a new borrowing benchmark designed by the Federal Reserve Bank of New York. That benchmark, called SOFR, or the secured overnight financing rate, is the leading replacement for the fading London interbank offered rate, currently used in setting interest rates on hundreds of trillions in debt.

Regulators plan to phase out Libor by the end of 2021 following a rate-fixing scandal which led to billion-dollar fines for several banks and prison sentences for some traders.

Repo rates are expected to fall should the Fed cut interest rates as expected at its meeting later this month. Analysts and investors expect that they will continue to trade at yields that are higher than other rates set by the Fed, such as IOER. “That supply story, with rates a little bit elevated, will continue,” Ms. Cunningham said.

While the repo rate could decline to reflect a lower Fed rate, yields on other securities could fall more because their longer maturities often reflect expectations for additional cuts in the future, analysts said.

The supply of securities used for collateral in the repo market has grown as the Treasury has increased its sales of short-term debt to help fund rising budget deficits. The government has auctioned about $1.34 trillion of longer-term notes and bonds through June, compared with about $2.39 trillion for all of last year.

“If you have cash, you’re definitely being compensated for being in repo,” said Thomas Simons, a money-market economist at Jefferies Financial Group. “It would behoove you to continue concentrating in the short-term because rates are definitely heading lower.”

Write to Daniel Kruger at

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