Banks Likely ‘End Game’ for Repo Market as Treasury Supply Grows

Banks will have a bigger footprint in the market for repurchase agreements as US Treasury coupon bond issuance swells and demand for financing grows in the coming years.

The supply of new Treasury coupons is expected to increase by over $3 trillion in the next two years, which means Wall Street will need to find another $200 billion to $400 billion of additional repo, according to Citigroup Inc. strategist Jason Williams, in a note dated Aug. 23.

With balances at the Federal Reserve’s overnight reverse repo facility, or RRP — considered an alternative to T-bills or private market repo — potentially close to being drained, actual bank participation in the market is more critical, he said.

That’s becoming all the more important for market participants who rely on the repo market for real-time indications of stress — like the ructions seen in September 2019 — as the Fed gets

closer to the end of its balance-sheet unwind. Already, the overnight rates have spiked to unusual levels because primary dealers’ are already stuffed with Treasury supply, constraining their normal function as an intermediary in the market.

Banks will “eventually become the end game as the marginal cash lender in repo markets,” he wrote. “Given that T-bill supply will be growing as well – and likely utilizing some or all of the remaining RRP cash – we think bank portfolios will have to be tapped for reserves at some point.”

It just remains uncertain how much cash banks would be willing to put into the repo market. Bank of America strategists last month estimated that banks — currently sitting on about $3.36 trillion of reserves stashed at the Fed — may have lending capacity of around $100 billion to $200 billion, an amount that would only keep repo rates in check for a couple of months with larger Treasury coupon auction settlements expected.

Williams noted that domestic banks lent about $100 billion in December 2023 and the second quarter of this year as repo rates moved above interest on reserve balances, or IORB — currently at 5.40%. During both of those periods, volatility drove the Secured Overnight Financing Rate to an all-time high of 5.40%.

Some of the larger Global Systemically Important Banks, or GSIBs, have cash to “spare” for lending into repo, he said.

“We will need to see what rate large banks demand as reserves fall,” Williams added.