Key facts
- Treasury repo rates have become more volatile and are trading above the Fed's target range.
- Traders are increasing levered Treasury trades, with hedge fund long positions rising by nearly $400 billion.
- Bank reserves have fallen to approximately $2.8 trillion, a level considered by Fed Governor Christopher Waller to be near the "ample" threshold.
- The Federal Reserve is reportedly working behind the scenes to manage potential disruptions in short-term dollar funding markets.
- Increased Treasury issuance and drawdown of cash from the Fed's reverse-repo facility are contributing to tighter overnight liquidity.
US funding markets are experiencing increased volatility and higher borrowing costs in the repo market, driven by traders betting against Treasury securities. The general collateral (GC) repo rate has been trading above the Federal Reserve's target range, with one instance on Tuesday at 4.05% and another at the end of October reaching 4.25%.
This tightness in short-term dollar funding is occurring as bank reserves have fallen to approximately $2.8 trillion, a level close to Fed Governor Christopher Waller's estimate of "ample" reserves at $2.7 trillion. This is still more than double the roughly $1.4 trillion level that preceded the 2019 repo spike, suggesting liquidity is thinner but not yet at 2019-crisis levels.
The Federal Reserve is reportedly monitoring the situation and working to manage potential disruptions. Primary dealers borrowed a record $50.35 billion from the Fed's Standing Repo Facility (SRF) in a single day, followed by a separate $22 billion repo operation. Despite increased use of the SRF, banks and dealers still hesitate to use it due to perceived stigma and less attractive capital treatment compared to private repo alternatives.
Several structural forces are contributing to higher repo rates, including larger Treasury issuance due to rising US debt, a higher Treasury General Account after a government shutdown, and the drawdown of cash from the Fed's reverse-repo facility. Hedge funds have also significantly increased their levered Treasury trades, with repo funding levels more than double those seen in 2019.