The 10 year Note has been making waves (at least in the places where people know just how much repo matters) recently for trading “special” at a negative repo rate of around -4% in the first week of March.

All this means is that it is trading at a repo rate that is unusual. When a particular financial instrument is in high demand in the repo market, it can trade “special”. 

What does a negative repo rate for the 10 year Note mean?

Firstly, a positive rate is the norm, and is the amount that a cash lender charges for lending their cash in exchange for receiving collateral (in this case the 10y Note).

In normal times, rates should be positive because lenders demand a return on the cash that they loan out, which is represented by the interest rate they charge.

With this as a reference point, negative rates mean the opposite. That is, cash lenders are paying counterparties to borrow money from them. This means that borrowers are getting paid to borrow.

Clearly lenders are desperate if they are resorting to this.

Which begs the question: desperate for what?

Simple. 10 year Notes.

Here, the picture gets a lot more muddled. Why would some parties be so desperate for 10y Notes?

A simple and easy answer is that demand for 10y Notes are through the roof because so many are looking to borrow them in order to sell them short.

Of course, this is part of the “boom times” narrative, which has caused a mad scramble of people betting on higher inflation. The result of this has been heavy selling in the 10 and 30 year Treasuries, leading to the much talked about spike higher in their yields.

However, we all know that simple/easy answers rarely tell the full story in complex systems like financial markets.

In this instance, the rush to borrow 10y Notes in repo has actually exacerbated a much broader problem – that of repo collateral shortages. 

While many may not be aware of it, USTs serve a more vital purpose in the financial system than simply funding the US government. They also serve as collateral in the very large global repo and Eurodollar markets.

Unfortunately, QE has removed, and continues to remove, large amounts of USTs from the system, leading to a shortage in repo collateral.

Shortages naturally lead to hoarding (the liquidity problems reported in the media), which means lower supply and availability in repo. Throw into this a spike in borrowing demand for the 10y from frenzied short sellers, and all of a sudden folks are willing to pay to lend cash just so they can get hold of 10y Notes.

Ultimately, repo is one of the most opaque markets in the financial universe, and it is always difficult to know with any certainty what currents are flowing through it.

It is even harder to ascertain how these currents will spill out into more observable markets, such as USTs.

As such, one can never be fully certain of any narrative’s explanatory power. What one can be certain of, however, is that problems in the repo market tend to blow up in large and unexpected ways.

Hence, the real problem today isn’t “boom times” and the assumed incoming inflationary storm, it is collateral shortages at the heart of the world’s financial system!