While markets were in a festive mood on New Year's Eve, with the S&P enjoying a last second 15-point spike even as 10Y yields tumbled to the lowest level since January...
... something strange took place in both overnight funding markets and the Treasury market.
While it is well-known that dealers tend to "window dress" their books on the last day of the year by curtailing activity in financing markets to shore up balance sheets, what happened on Monday left quite a few mouths wide open: with the General Collateral rate trading around 2.50% on Friday, Monday saw a historic surge in overnight GC repo, that sent the rate surging by the most ever, spiking sharply to 6.125% on Monday morning, with the bid/ask trading 6.50%/5.75% just after 10am after opening Monday at 3.75%/4.00%, which was already nearly 1.50% higher than the Friday close (incidentally, the Broad General Collateral Rate (BGCR) was set at 2.45%, the same as the Tri-party General Collateral Rate).
In fact, the closing print of 6.125% was the highest GC repo rate observed since January 2001, and just under 400 bps higher than the Fed funds rate.
"The cash never came in," said Scott Skyrm, EVP at Curvature Securities, noting that "funding pressure should be about 50 basis points. This was 350 basis points."
Indeed, confirming the need for cash, on the last day of 2018, 17 counterparties took only $41.8BN at the Fed’s overnight reverse repo operation on Monday, up from $3.21b on Friday, which was the second-smallest quarter-end usage since the RRP was created in 2013, and suggesting that instead of padding books with cash-equivalent securities to satisfy regulatory requirements, banks were suddenly strapped for cold, hard cash.
Clearly there was something amiss with year end liquidity: while there have been year end spikes in the repo rate all prior years, not once in the past decade was the surge as high as it was this time, prompting questions if there were broader year-end liquidity plumbing issues in the market than just traditional window dressing.
Meanwhile, in yet another bizarre manifestation of year-end liquidity events, on Monday shortly after a 52-week Bill auction priced amid unremarkable results, the short-end of the curve inverted dramatically, with the yield on the 1Y finding itself more than 10bps higher than the 2Y.
In fact, the yield on the 52-week Bill closed Friday at 2.5986%, higher than the yield on the 7Y TSY which was at 2.5869%, meaning the 1s7s was inverted.
The last time the 1s7s curve inverted? You guessed it - the same time the overnight repo rate surged as much as it did on Monday - back in early 2001.
One reason cited for the bizarre shape of the yield curve was the bond market's confusion about what the Fed will do, with the short-end still anticipating perhaps one or more rate hikes, while the longer-end increasingly pricing in deflation, rate cuts and, eventually, QE, although since both of those expectations are what makes up the shape of the yield curve by definition, that explanation was left wanting.
As for the record spike in repo, rates traders were left scratching heads, with Curvature's Skyrm warning that market participants may have to start pricing in the fact that if repo rates "spike up a bit, they could go much higher."