Bull steepening; Spreads widen
Treasury yields are ending the session 1 to 4bps lower, led by the 3y point. The 10y note yield is last 4.252% while 2s10s is last 1bps steeper at -73.34bps while 5s30s is 3bps steeper at -4.5bps. Equities are ending mixed (DJIA -0.20%, S&P +0.09% and Nasdaq +0.29%).
Earlier the $20bn 30y reopening came with a 1bp tail versus the 1pm bid side, drawing a rate of 4.345%. Indirects fell (64.5%) while directs rose very marginally (19.7%), leaving primary dealers with a higher 15.8% allocation. The bid-to-cover, however, was slightly firmer. Overall, sources aren’t finding much to hang on thematically in the tightly bound price action, and liquidity remains low.
Meanwhile, IG new issuance (ex-SSA) saw a much lighter session, with only $2.05bn priced by three issuers. Week to date now stands at $32.05bn, thus exceeding the $30bn forecast for the week. MTD is now $87.6bn. With the noticeable drop in swapped supply, swap spreads widened out progressively into the end of the session, amid mostly lower volumes .
2s -10bps (+0.5bps), 3s -13.75bps (+0.25bps), 5s -21.5bps (+0.25bps), 7s -30.125bps (+0.375bps), 10s -29.375bps (unch), 20s -63.875bps (+0.375bps), 30s -67.5bps (unch).
Potential for funding risk in UST basis – Barclays
Analysts at Barclays find that cash futures basis trades face two sources of funding risk: “liquidity scarcity from the Fed's QT and capital drag pressure from an expansion of sponsored repo” and “while the latter reduces balance sheet intermediation pressure, it comes at a higher capital cost.”
To recap UST basis, Barclays explain “in a cash futures basis trade, the investor is long a Treasury while simultaneously short the corresponding future” and thus “financing the long cash position requires dealer balance sheet.”
As a result, “a sign that this trade has become more popular is a simultaneous increase in short futures positions and in sponsored repo volume” but it points out that “since May, while hedge fund short futures positions have grown, sponsored repo volumes have held steady.”
Barclays points out instead “there are other ways for dealers to preserve balance sheet capacity while financing the cash leg of these trades”:
- For example “they can structure the financing leg to include an offsetting short, in a sort of a package trade” such that “the investor will agree to short a short maturity coupon to its maturity date as a way to create the offset (netting position) for the cash funding position.”
Further, “these trades may be done on an uncleared basis” as “the offsetting cash funding positions are with the same counterparty and to the same date, they net under standard accounting rules without the need for clearing the trade through FICC,” the bank highlights.
Indeed, the bank finds that “while sponsored repo volumes have grown since last year, primary dealers' uncleared volumes have also risen – reaching 66% of their aggregate repo volumes at the end of August.” That said, Barclays points out that “primary dealers are not the largest providers of sponsored repo; instead, the biggest providers are custody banks that account for about 80% of aggregate sponsored activity.”
So far Barclays sees “few signs of funding rate pressure caused by balance sheet crowding” as “term funding spreads are narrower than in 2019 and overnight rates still trade close to tri-party levels.”
That said, Barclays sees two potential sources of funding risk in the coming year: “liquidity and capital drag pressure” and it finds “the latter is more of a threat as the Fed is likely to stop QT before liquidity scarcity drives funding costs higher.”
Barclays suggests that “Higher capital and liquidity requirements associated with sponsored repo suggests an upper limit on the amount dealers may be willing to supply” and “when this limit is reached, dealers could begin rationing sponsored repo access through higher funding rates,” it warns. (for related recent news on basis please see link).
- FWD Group (Baa2/BBB) is preparing a USD 10y through HSBC, JPM, MS, Mizuho and StanChart. Expected to price tomorrow.
- Korea Southern Power (Aa2/AA-) is preparing a USD 3y via Citi, Mizuho and Nomura after meeting investors on Sep 12.
- Sierra Pacific Power Co. priced a $400m 30y deal via BofA, JPM, MIX, RBC and TSI. A2/A+. +160bps.
- Marriot International priced a $1.15bn 2-part ($450m 3y and $700m 5y). Leads BofA, GS, PNC and USB. Baa2/BBB. +100bps, +130bps.
- CenterPoint Energy Houston Electric priced a $500m 5y deal via MUFG, PNC, RBC, Scotia and TD. A2/A/A. +85bps.