Why Is Reverse Repo Use So High? Focus On Collateral! 2
Interestingly, Low Yields in 5 year Note auctions have dived lower over the last few months, following the same pattern as those set by the Bills (but not the 2 year Note).
While High and Median Yields have not fallen by much, Low Yields are lower by approximately 60 basis points since March.
We observe the same thing in 7 year Notes, with High and Median Yields maintaining their levels (and tight spread), while low yields plunged.
The drop in Low Yield at the most recent auction of 7y Notes held near the end of May came in 80 basis points lower than it had previously. Not only was it a sharp drop, it also pushed the Low Yield back to its lowest levels over the past year, 0.08%.
As you can see in the chart above, Low Yields in the 7y Note auctions sat at 0.08% in the direct aftermath of March 2020’s crisis, and then later for most of the remainder of the year.
In 2021, they fell back to 0.8% in March, and then again in the most recent auction.
Moving even further out the yield curve to the 10 year Note, we observe that auction Low Yields still have not caught up to High and Median Yields; and remain in their 80 basis point range between 0.08% and 0.88%.
Taken together, auction Low Yields across multiple maturities on the UST yield curve have moved lower over the last 3 or 4 months, to levels last seen during March 2020.
2 year Notes are the exception to this, although its Low Yields are still in “ultra low” territory, sitting just above 0%.
Given the sky high use of the Fed’s o/n Reverse Repo, now at $485 billion (as of 27 May), $200 billion more than at the peak of last year’s Covid related financial panic, it really isn’t surprising that auction demand for T Bills is as strong as it is.
What is concerning, however, is the sharp dive in 5 and 7 year auction Low Yields during their most recent auction, as this hints at market participants scrambling to get their hands on collateral other than everyone’s preferred T Bills.
This can be for a multitude of reasons, from traders failing to secure enough Bills for their needs, pushing them to use 5y Notes, to investors purchasing USTs that are further out on the curve in anticipation of a coming “liquidity event”.
Either way, they point toward a shortage of USTs, which negatively impacts collateral availability in the repo market, and by extension, financial system stability.
What is truly frightening, however, is that the shortage keeps growing larger!
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