Citi: As US Treasury supply surges, repo rates to be "dominated" by Wall Street banks
With the increase in US Treasury supply, Citigroup analysts predict that Wall Street banks will occupy a larger share in the repurchase market. He pointed out that the issuance of new US Treasury bonds in the next two years will increase by more than $3 trillion, requiring banks to find an additional $200 billion to $400 billion in repurchase funds. Given that the Federal Reserve's reverse repurchase tool balance is close to depletion, banks' market participation becomes more important. It is expected that high repurchase rates and market volatility will affect banks' lending capacity and capital deployment
According to CNBC, as the issuance of US Treasury bonds is expected to increase by more than $3 trillion over the next two years, Wall Street banks will have a larger share in the repurchase agreement market to meet the growing financing needs. Citigroup strategist Jason Williams stated in a report dated August 23 that Wall Street will need to find an additional $200 billion to $400 billion for repurchases. He mentioned that as the Federal Reserve's overnight reverse repurchase (RRP) tool may be close to depletion, actual bank participation in the market is crucial. RRP is considered an alternative to US Treasury securities or private market repurchases.
As the Federal Reserve's balance sheet contraction nears completion, it becomes increasingly important for market participants who rely on the repurchase market to observe real-time liquidity pressures, similar to the turmoil seen in September 2019. At that time, US overnight rates had surged to unusual levels as primary dealers were inundated with US Treasury supply, limiting their normal function as market intermediaries.
Williams wrote that banks will "ultimately become the marginal cash lenders in the repo market." He added, "Given the increase in short-term Treasury supply and the potential use of some or all of the remaining RRP cash, we believe that at some point, bank portfolios will have to use reserves."
It is still uncertain how much cash banks are willing to inject into the repurchase market. Bank of America strategists estimated last month that banks currently hold around $3.36 trillion in reserves at the Federal Reserve, with their lending capacity likely around $100 billion to $200 billion. This amount will only control repo rates for a few months as larger US Treasury coupon settlements are expected.
Williams pointed out that with repo rates higher than the interest on reserve balances (IORB), US domestic banks lent around $100 billion in December 2023 and the second quarter of this year, with the IORB currently at 5.40%. During these periods, market volatility drove the Secured Overnight Financing Rate (SOFR) to a historical high of 5.40%.
Williams mentioned that some larger globally systemically important banks have "excess" cash available for repo lending. He added, "We need to observe the rates that large banks demand as reserves decline."