NEW YORK, Oct 21 (Reuters) - The U.S. secured overnight
financing rate (SOFR), the Libor replacement preferred by the
Federal Reserve that measures the cost of overnight cash in the
repurchase (repo) market, stayed at 0.03% for a second straight
day after holding steady at 0.05% for the last four months.
Analysts attributed the unexpected decline to recent
volatility in short-dated Treasuries and excess cash from
government-sponsored enterprises (GSEs).
The current SOFR number reflects Wednesday's rate. The New
York Fed publishes the SOFR each business day at 8 a.m. ET.
The drop to 0.03%, which started on Tuesday, was unusual and
caught market participants by surprise. SOFR was at
0.05% since June 17, a day after the Fed raised the reverse repo
rate and the interest rate on excess reserves, aimed to keep its
overnight benchmark rate from falling too low.
The decline in repo rates followed a surge in
short-positioning in short-dated Treasuries, analysts said, as
expectations grow for an earlier-than-expected Fed rate hike
next year. To short 2-year notes, for example, investors borrow
them from entities such as money market funds, sell them, and
repurchase them later.
These U.S. 2-year notes became what are known as "repo
specials," referring to securities that have overwhelming demand
in the repo market. Competition to buy or borrow a special
security prompts potential buyers to offer cheap cash in
exchange.
On Thursday, U.S. 2-year notes traded the most "special"
among Treasury securities, with repo rates of borrowing it at
-1.56%. Market participants were willing to pay interest on
money lent to borrow the 2-year note, instead of the borrower of
cash who usually pays interest for the loan.
Also, on the 18th of each month GSEs like Fannie Mae and
Freddie Mac invest cash in the repo market as they receive
mortgage payments from homeowners. That typically pushes repo
rates lower. When they make their principal and interest
payments on the 24th, that GSE cash leaves the market, pushing
repo rates higher.
"The SOFR decline leads to questions about the stability of
the rate set to become the new U.S. dollar benchmark once libor
goes away," said Dan Belton, fixed income strategist, at BMO
Capital in Chicago.
"A lot of investors were skeptical of the rate to begin
with, mostly because of its lack of a credit component. So the
fact that it can drop so far within the Fed's target range, just
3 basis points from the bottom, and unexpectedly, adds to the
questions about the rate's shortcomings as a benchmark."
(Reporting by Gertrude Chavez-Dreyfuss in New York
Editing by Alden Bentley and Matthew Lewis)