Another Market Dislocation: General Collateral vs Fed Funds, Now At Widest Divergence Of 2010

The most recent notable dislocation in a market now replete with broken correlations, comes courtesy of an observation by Barclays' Joseph Abate who notes that the General Collateral Repo, at 0.29%, rate has surged to a 2010 wide compared to the effective Fed Funds rate, an arbitrage that should not exist for structural (secured vs unsecured) and practical (the spread should be immediately "arbed" out by the numerous banks who participate in both markets) reasons. Yet it does. Joe Abate presents a technical explanation on why this may be happening, although a far simpler, and far more elegant reason is that all repo pledgable USTs have now gone "special" as few traders are willing to take the MTM hit on even an overnight holding in USTs (remember repo is broadly an overnight trade), and thus crossing a bid-offer in GC repo is becoming increasingly problematic. In other words, the Fed's actions vis-a-vis the Fed Funds rate and its intervention in the 10-30 Year part of the curve is starting to throw curve balls to the money market. We will be closely following the GC-FF spread: it is at the 2010 wide already. Further widening should set off alarm bells that not all is well in the money market. Alternatively, it could all very well just be noise.

General Collateral:

General Collateral to Effective Fed Funds Spread:

And below are Abate's thoughts on this very peculiar divergence:

The settlement of more than $40bn in net new coupon supply briefly pushed the general collateral rate to 27bp on Monday morning. However, with little additional new collateral supply through month-end, we expect repo rates to settle back into their recent 20bp or so range.

Puzzlingly, general collateral continues to trade higher than the effective funds rate – something of a theoretical anomaly given the difference between secured and unsecured borrowing costs. It is also a bit surprising given the ability of participants in either market to arbitrage the spread away, since the same institutions that trade repo often trade in the fed funds market. Of course, there are some limitations to the arbitrage – including the fragmented and depopulated fed funds market. As we have observed, the Fed’s liquidity injections boosted the level of bank reserves significantly and eliminated to need for banks to borrow in the overnight unsecured market. Similarly, because the GSEs earn nothing for leaving cash uninvested at the Fed, they have pushed out into other markets – such as repo and bills. Indeed, Fed statistics reveal that in most weeks, the GSEs leave only a trivial $300mn on deposit at the Fed. The lack of liquidity in the fed funds market is probably limiting its role as an arbitrage to repo.

More technically, a timing difference might account for some of the divergence between overnight repo and the effective funds rate. Since repo is mostly traded before 10am, it tends to be more correlated with the opening fed funds quote. The effective fed funds rate, by contrast, is heavily influenced by the volume (and rate) of trading in the final 90 minutes of the day. In recent days, GC has tended to open higher than it trades later in the day. Thus, while the relationship between secured and unsecured rates may have diverged, afternoon rates suggest that perhaps it hasn’t  disappeared entirely.

Comments

[TooBearish]

Dood its settlement day for the auctions from last week - pull in them horses Joe!

[Tyler Durden]

There have been over 20 settlement days in 2010, and just one day when the spread was as wide as it is.

[nostromo17]

If a bond goes special the repo rate goes down not up since the rate is for the money lending side and if the bond is valuable to own the money rate is adjusted down....so you graceful argument is upside down. Sounds like plenty of GC available at the moment.

The ff-GC spread will close up again.

[TooBearish]

Point taken Ty however I would point out that the spikes on the graph do seem to be centered around mid month settlement day and interestly 'nuff the compression occurs right around Q end - repo 105 maybe to get the Bal Sheet down? 

Just a tad of congestion tomorrow the spread will adjust - but hey TSCHTF anytime....

[RobotTrader]

Yet another attempt to U-Turn this thing???

[Bear]

Thanks for watching this for us ... when cash is king, money markets are god!

[old_turk]

Part deux of the paradox (and explains what should not happen but does) with this divergence is, just how many 'failed' trades are going on right now?

As I recall, the Lehman strains were showing up with repo 105s and lots and lots of 'failed' repos.

Structurally, it indicates trouble in credit land, whether it's a money center bank or just a general, 'go borrow from the fed, yer paper ain't no good 'round here', I don't know.

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