SOFR tipped to hit 300bp at quarter-end

A broad measure of US overnight repo rates is expected to surge by nearly 25% to around 300 basis points at the end of March, as quarter-end leverage ratio window-dressing from French banks takes effect and a glut of new US Treasuries enters the market.

The twin drivers were partly blamed for pushing the Secured Overnight Financing Rate (SOFR) – the new benchmark measuring US repo – up 54bp to 300bp on December 31, while the general collateral repo market hit intraday highs of 725bp. The overnight SOFR rate was 244bp as of March 27, according to Bloomberg data. Repo experts predict another leap in rates on March 29, but say any uptick will be less extreme than year-end.

“This quarter-end is a bit of a crapshoot,” says a repo trader at a European bank. “Borrowing over the quarter-end has traded between 325bp and 385bp, and last traded at 348bp. I don’t think we will see the crazy pressure of year-end as the G-Sibs [global systemically important banks] will be more involved in the trade.”

The head of repo at a US bank agrees: “I think it will be more subdued than the end of the year, but we will see elevated funding pressure.”

This quarter-end will also be the Japanese financial year-end, which the repo trader describes as “the great unknown” in terms of market impact.

The surge in year-end repo rates that make up SOFR – the US Federal Reserve’s preferred alternative index to US dollar Libor – caught out a number of institutions, which were left scrabbling for funding on the last trading day of the year. A combination of G-Sib reporting requirements and $51 billion of US Treasury issuance hitting the market were blamed.

To raise cash to buy the flood of Treasuries, primary dealers had to repo out their existing holdings, pushing up the rate in the process. But despite increased demand for repo from the wider market, most dealers sat on their hands, with JP Morgan being the notable exception.

The US Treasury has issued $113 billion of securities today (March 28), adding $8 billion of net bill supply to market, and is due to issue a further $158 billion at the beginning of April.

To navigate these spikes better, the market has seen a wave of derivatives activity over the March quarter-end. For example, two SOFR interest rate swaps – one for $6 billion and one for $3 billion – hit the market last week, which traders put down to either a bet or hedge on further rate spikes.

CME Group, which lists one-month and three-month futures products tied to SOFR, has also seen a jump in activity. The exchange saw two separate block trades of 5,400 one-month contracts – a record size – hit the market this month. Sean Tully, the firm’s global head of financial and over-the-counter products, says this was another play on quarter-end.

What is notable now is – because of the Federal government’s financing needs – the large amount of US Treasury coupon supply that is hitting the market on a regular basis. That change is a lot for the market to absorb

Susan Hill, Federated Investors

“The only unknown risk is the rate risk this week, so it’s about the turn. All of those block trades are about quarter-end and Japanese financial year-end,” he says.

Repo rate spikes have become expected at quarter-ends thanks to a quirky difference in how the leverage ratio has been applied in different jurisdictions, helping French banks become some of the biggest players in the US repo market in recent years.

Under rules adopted by the European Commission on October 10, 2014, European banks are required to measure and report their leverage exposures at the end of the quarter, while US banks must calculate their exposures on a daily basis. This means French banks typically blow up their repo balances during the quarter before slashing them at quarter-end, resulting in repo rate spikes over these periods.

Recently, this quirk has also started occurring at month-ends that do not fall on those key reporting dates. For example, SOFR saw a 19bp jump on January 31 and a 21bp hike on February 28, before settling down to more normal levels the next trading day.

Some market participants put this down to the impact of increased US Treasury issuance. On each of those days in 2017 and 2018, the US Treasury issued less than $100 billion of new securities. However, this year it issued $193 billion on January 31 and $226 billion on February 28.

“What is notable now is – because of the Federal government’s financing needs – the large amount of US Treasury coupon supply that is hitting the market on a regular basis,” says Susan Hill, a senior portfolio manager at Federated Investors. “That change is a lot for the market to absorb.”

Others feel European banks may have decided to start adjusting balance sheets on month-ends as a way to eventually move to daily averaging. This could be in response to a Basel Committee on Banking Supervision statement on October 18 that described the practice of window dressing as “unacceptable”, and called for supervisors to require more frequent reporting and public disclosures to clamp down on the activity.

“Given that leverage ratio will eventually be a daily calculation, some market participants have been moving toward the target. Month-ends would be a logical place to start,” says one repo trader at a European bank.

The amount of new US Treasury issuance might also explain the hangover effect, as repo rates remain elevated in the days after quarter-ends, despite intermediaries like French banks coming back into the market. SOFR traded at 315bp on January 2 and 270bp the following day as $171 billion of US Treasuries were issued at the beginning of the month.

“I think [US Treasury issuance] is definitely a factor, and one we consider when we’re evaluating where repo is trading on a daily basis,” says Hill.