Here’s One More Theory on What’s Causing the Repo Squeeze

(Bloomberg) -- Investors betting yields on long-term bonds will rise may have helped fuel the recent surge in money market rates, according to Coutts & Company Chief Investment Officer Alan Higgins.

So-called 2s10s steepeners, where investors buy two-year U.S. Treasuries and sell 10-year notes, have become a popular macro trade among banks and some hedge funds, said Higgins. Most of these trades are funded through the repo market.

“We have the trade on ourselves,” Higgins told Bloomberg Radio on Wednesday. “I’m wondering if that’s where the crunch is coming from.” The tightness in the money market is “no indication” of bank distress, he added.

In a typical 2s10s steepener trade, an investor may need to fund, say, four units of two-year notes which would be partially offset with a short position in one unit of 10-year bonds. The net funding need for the trade is therefore for three units, which would normally be obtained via the repo market.

It’s another potential piece of the jigsaw as investors grapple with this week’s turbulence in the money market, where the rate on one-day loans backed by Treasuries -- known as repurchase agreements, or repo -- jumped to as high as 10%. The surge is a sign that Wall Street firms, which have been absorbing record government debt sales, are struggling to meet the funding demands of participants. Cash was also sucked out of the system because companies have quarterly tax payments to make.

The Federal Reserve stepped in to calm the market on Tuesday by injecting billions of dollars. The central bank said it’s willing to spend another $75 billion on Wednesday.

To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net;Anna Edwards in London at aedwards49@bloomberg.net;Matthew Miller in New York at mtmiller@bloomberg.net

To contact the editors responsible for this story: Samuel Potter at spotter33@bloomberg.net, Paul Dobson

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