Treasury 10-Year Notes Rise as Fed Begins to Test Reverse Repos


Oct. 19 (Bloomberg) -- Treasury 10-year notes rose after the Federal Reserve said it’s working with counterparties to test a system to withdraw the unprecedented amount of cash injected into the financial system the last two years.

Central bank officials are discussing plans to use so- called reverse repurchase agreements where the Fed sells securities to its 18 primary dealers for a specific period, temporarily decreasing the amount of money available in the banking system. “No inference should be drawn” on a tightening of monetary policy, the Fed said in a statement today.

“People are convinced the Fed is not going to be raising rates anytime soon and when that happens, they feel comfortable extending out the curve,” said John Spinello, chief technical strategist at primary dealer Jefferies Group Inc. in New York.

The yield on the benchmark 10-year note fell 3 basis point, or 0.03 percentage point, to 3.38 percent at 4:41 p.m. in New York, according to BGCantor Market Data. The 3.625 percent security due August 2019 rose 8/32, or $2.50 per $1,000 face amount, to 102.

The breakeven rate, or the difference between yields on 10- year inflation-indexed securities and Treasuries of the same maturity, touched 2.037 percent, the widest since Aug. 10, when it registered 2.046 percent. It dropped to a low this year of .051 percent on Jan. 2. The gap represents traders’ expectations for the rate of inflation over the life of the bonds.

The yield on the two-year note rose 1 basis point to 0.96 percent, after climbing to 0.99 percent, the highest this month.

“It’s a good first step,” said Brian Edmonds, head of interest rates at primary dealer Cantor Fitzgerald LP in New York. “It’s not a huge change in Fed policy, but at some point it’s a tool to slowly take accommodation out of the market.”

Reverse Repo

At maturity of a reverse repo, the securities the Fed sold to the dealers are returned to the central bank, and the cash goes back to the companies. The reverse repurchase agreements contemplated by the Fed would need to be for a longer period and larger size than has been typical in previous open market operations, strategists have said.

Securities dealers use repos to finance holdings and increase leverage. Bonds that can be borrowed at interest rates close to the Fed’s target rate for overnight loans between banks are called general collateral.

The Fed performed tests of reverse repos with primary dealers through tri-party clearing banks in the last month. Reverse repos have typically been settled through a delivery versus payment, or DVP, method where the central bank sends the securities to the dealers’ clearing banks, which causes a simultaneous movement of money, according to the New York Fed’s Web site. The Fed has conducted tri- party repurchase agreements with primary dealers since 1999.

Tri-Party Repos

In a tri-party arrangement, a third party known as a clearing bank functions as the agent for the transaction and holds the security as collateral. JPMorgan Chase & Co. and Bank of New York Mellon Corp., both based in New York, are the only banks that serve in a trade-clearing capacity in the tri-party repo market.

“The Fed statement served the purpose to get the market prepared in case the FOMC decides to say something about the reverse repo at the next meeting,” said Alex Li, an interest- rate strategist in New York at primary dealer Credit Suisse AG.

An article in Barron’s on Oct. 17 suggested the Fed should raise rates to 2 percent or risk facilitating another bubble. “It’s time for the Federal Reserve to stop talking about an exit strategy and start implementing one,” the article said. “There is no need for short-term rates to remain near zero now that the economy is recovering.”

‘Moving Out Slowly’

Fed Chairman Ben S. Bernanke and fellow policy makers cut the target rate for overnight loans between banks to a range of zero to 0.25 percent at the end of 2008. They will keep the target there until the third quarter of 2010, when it will increase to 0.5 percent, according to the median estimate of economists surveyed by Bloomberg News from Oct. 1 to Oct. 8.

“The Fed has time on its side before making a drastic move to 2 percent,” wrote George Goncalves, chief fixed- income rates strategist at primary dealer Cantor Fitzgerald LP, in a note to clients. “Moving out slowly will allow them to gauge if markets can stand on their own two feet.”

Treasuries fell last week as reports on manufacturing and industrial production added to evidence of an economic recovery, tempering investors’ quest for higher-returning assets amid subdued inflation.

‘Not Far Away’

Waning demand for U.S. securities will push the yield on the 10-year note to 3.80 percent by the middle of next year, according to a Bloomberg survey of banks and securities companies, with the most recent forecasts given the heaviest weightings.

“At some point, the Federal Reserve will divest itself from its vast ownership of U.S. government debt and when that happens or begins to happen, higher rates are likely not far away,” wrote Kevin Giddis, head of fixed- income sales, trading and research at the brokerage Morgan Keegan Inc. in Memphis, Tennessee, in a note to clients today.

U.S. government securities lost investors 2.8 percent in 2009, according to Merrill Lynch’s Treasury Master Index. That compares with returns of 1.4 percent from German bonds and 0.2 percent from Japanese debt.

The Treasury is slated announce on Oct. 22 that it will sell $7 billion in five-year TIPS, $44 billion in two- year notes, $41 billion in five-year debt and $30 billion in seven- year notes, according to Wrightson ICAP LLC, a Jersey City-based research firm that specializes in government finance. The Treasury will auction the notes on four consecutive days beginning Oct. 26.

To contact the reporters on this story: Susanne Walker in New York at swalker33@bloomberg.net; Liz Capo McCormick in New York at emccormick7@bloomberg.net


E' solo un test o ci avviamo alla fine delle regalie di liquidità e dunque all'aumento dei tassi?

:mmm: