Earlier this week, when looking at the rapidly fraying dynamics in the all-important Treasury repo market, we explained that as a result of the unprecedented, record shortage of underlying paper, the repo rate for the 10Y has plunged to the lowest on record (and even surpassing it on occasion), the -3.00% "fails" rate, an unstable, broken state characterized by a surge in failures to deliver and receive, when one party fails to deliver a U.S. Treasury to another party by the date previously agreed by the parties. Think of it as a margin call issued on a stock in which the responsible party refuses to comply, and is instead slapped with a token penalty, or "fails" fee.
This is precisely what has been going on with the Treasury market for over a week, ever since last Friday when we first pointed out the precarious collapse in the repo rate on the 10Y - traditionally the best indicator of stress in lending markets.
There was some expectation that after this week's 10Y and 30Y auctions, that the shortage would moderate, however so far that has not happened, and now the last possible renormalization date is when these auctions settle early next week.
For now, however, things are going from bad to worse, and as Stone McCarthy shows in the following two charts, it is no longer just the 10Y which is in trouble: so is the 30Y, which as of this morning is trading near the fails range, or -2.40% in repo.
But more importantly, we no longer have to rely on the repo market to see just how broken the Treasury market has been this past week as a result of what has been an unprecedented shorting onslaught. As of this morning, the NY Fed's Primary Dealer database was updarted for the most recent failures to deliver and receive data, and it is a doozy when it comes to 10Y paper.
Here are the facts:
- 10Y fails to deliver surged to $32.3b for week ended March 2 vs $132m previous week and fails to receive jumped to $31.8b vs $259m, both highest since June 2013, amid increased short base and lack of supply before this week’s auction.
- Total fails to deliver rose to $178.1b vs $139.5b; fails to receive rose to $171.9b vs $135.3b
- UST ex-TIPS fails to deliver $127b vs $70b, highest since Jan. 6; fails to receive $127.7b vs $74.6b, highest since Dec. 30
The one chart that summarizes what is going on is shown below: as of this moment, there are more "failures" both to deliver and receive than just one time in history, June 2013.
Using the Fed's revised data set, it is sadly impossible to go further back than April 2013 to see how this compares to the broken Treasury market around the time of the Great Financial Crisis, but we are confident it is comparable.
One thing is certain: as a result of the Fed's massive balance sheet holdings of Treasury securities, and the dramatic shorting onslaught, the Treasury market - at least as of this moment - is broken.
Here are some further thoughts on this disturbing matter from RBC rates strategist Michael Cloherty who says that "while surge in Treasury fails affecting OTR 10s and 30s “should largely clear up” when this week’s auctions settle, “we are viewing this event as a glimpse of the post-Fed reinvestment future. When the Fed eventually stops rolling over maturing Treasuries, there will be no lendable supply of the on-the- runs through the SOMA,” meaning that “fails in on-the-runs will be chronic and protracted, bloating balance sheets and raising questions with certain PTF models”
He adds that treasury fails “have been trending higher for some time,” but most have been “fairly short-lived off-the-run fails." This time it may be different as drivers of current episode include “the fact that these issues were auctioned at the yield lows, so some investors are reluctant to sell them at a loss.”
We can only hope that the Fed will address this most important "broken market" before it is too late, unfortunately for that to happen the Fed would have to sell some of its Treasury holdings, and that would unleash a risk off wave across all asset classes, which as Mario Draghi showed yesterday beyond a doubt, is simply not acceptable to central banks.
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