Why The Repo Market Will Need The Fed’s Cash Yet Again | Scott Skyrm & Joseph Wang
Apr 29, 2022
54:51
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Quick takeaways
As the Fed reduces its balance sheet, treasury and agency securities flooding into the market will increase the demand for repo financing, causing repo rates to rise and treasuries to become cheap relative to futures and swaps.
The dynamics between specials (current issues being traded with higher demand) and general collateral (less in demand securities) can impact repo rates and security valuations, with borrowers paying a premium to borrow specific securities.
Deep dives
The Repo Market and its Functions
The podcast explores the repo market, which is a huge but often misunderstood market. The guest, Scott Skirm, is an executive vice president at Kerberstich Securities and an insider in the repo market. He explains that the repo market is a collateralized loan market, where cash investors lend their cash to investors who need to finance their treasury positions. The market revolves around borrowing and lending securities, particularly US Treasuries, and it plays a crucial role in the overall financial system. The repo market is driven by factors such as treasury issuance, leverage, and demand for specific treasury issues.
The Role of Balance Sheet Runoff and Quantitative Tightening
Scott Skirm discusses the potential impact of balance sheet runoff or quantitative tightening (QT) on the repo market. He predicts that as the Fed reduces its balance sheet, treasury and agency securities will flood into the market, leading to increased demand for repo financing. He expects the reverse repo facility to absorb the excess cash from money market funds, which will provide financing to hedge funds and other investors buying treasuries. Scott forecasts that as supply increases and the RRP drains, repo rates will rise and treasuries will become cheap relative to futures and swaps. Overall, he believes that the repo market will be able to withstand the pressures of balance sheet runoff and continue to function as a crucial source of financing.
Specials and General Collateral in the Repo Market
The podcast delves into the concept of specials and general collateral in the repo market. Scott Skirm explains that specials refer to on-the-run treasury issues, which are the current issues being traded in the market. These issues tend to have higher demand and tighter bid-offer spreads due to hedging and speculative trading. General collateral rates, on the other hand, involve non-specific treasuries and agency securities that are less in demand. Scott highlights that the demand for specials and the accumulation of short positions can lead to negative or low repo rates as borrowers pay a premium to borrow specific securities. He emphasizes that the dynamics between specials and general collateral can impact repo rates and security valuations.
The Future Outlook for the Repo Market
Based on his analysis, Scott Skirm provides insights on the future of the repo market. He anticipates that overnight repo rates will gradually rise to the top of the Federal Reserve's target range as treasury supply increases and the RRP drains. He expects the Fed's repo facility to play a significant role in providing financing for the market, resulting in repo rates going above the target range and a substantial amount of securities being held in the facility. Scott also highlights that treasuries may trade at a lower yield compared to futures and swaps, presenting opportunities for arbitrage and market activity. Overall, he believes the market will adjust to the changing dynamics and provide necessary financing for treasuries and other securities.
Scott Skyrm, Executive Vice President in fixed income & repo at Curvature Securities, joins former senior Fed trader Joseph Wang and host Jack Farley to share his insights from deep within the repo markets. Skyrm explores whether the Fed’s forthcoming balance sheet runoff will agitate repo markets like last time in September 2019, when repo rates spiked higher. Skyrm (@ScottSkyrm) and Wang (@FedGuy12) weigh important considerations, such as the Fed’s involvement with the market and what current repo rates indicate about the level of bond shorting.
Skyrm tells Farley (@JackFarley96) that the trillions of Treasury collateral that the market will have to absorb over the next year will drain the ~$1.8 Trillion in Fed’s reverse repo facility, yank repo rates higher, and eventually cause the market to rely once again on the Fed’s standing repo facility.
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BCB is Europe’s leading provider of business accounts and trading services for the digital asset economy. With a dedicated focus on institutional payment services, BCB Group provides business banking, cryptocurrency and foreign exchange market liquidity for some of the world’s largest crypto-engaged financial institutions.
For more information, please visit https://bcbgroup.com/jack
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