The developments around replacement of Libor and the evolution of SOFR as an alternative rate have been one of the most important events to follow in global markets in recent times. The SOFR surge event of 17th Sep 2019 (basically there was a significant spike in SOFR on that day attributable to a variety of reasons that has been adequately written about. See image below) raised questions about whether the markets and regulators have sufficiently thought through the appropriateness of SOFR as a benchmark to replace the all-important Libor (Fun fact: Libor said to linked to $400 trillion of wholesale and consumer global transactions!)
There might be another event quietly taking place right now, which in some sense can be said to be the other end of the spectrum on which the SOFR Surge event lies. Typically, short term rates are squarely in the domain of the Fed and there has been some evident pressure in the short term rates space since the Fed took away the SLR relief granted to Banks on the last day of March 2021. Below are 2 charts / images which illustrate the pressures on short term rates. While the Fed wants to steer clear of negative rates, (given the patchy track record of negative rates in Europe and Japan), the overnight rates in some quarters are being transacted at negative levels nonetheless.
The first graph shows the dollar quantum of transactions being transacted at the Reverse Repo window at the Fed (area marked in Red). The sheer amount of liquidity which basically has no other place to be parked at gets routed to the Reverse Repo window at the Fed. These are essentially transacted at 0%.
The second image shows the consistency with which some of the overnight secured transactions are being dealt in negative territory.
I would not profess to be an expert at monetary policy and rate transmission effects. However, this is a worthwhile corner of the market to keep track of. The long end of the rates curve is subject to the vagaries of the bond market. Does the Fed have adequate control of the short end? Investors should keep an eye on the developments in short term rates and monitor the above mentioned 2 data points.
Happy investing!
To learn more about US Treasury ETFs that invest in the shorter end of the interest rate curve, take our Fixed Income Analysis course and watch the video at the below link!
The US Treasury ETFs – The Credit Balance
Materials worth reading
Policy recommendations for enhancing the liquidity of the US Treasury markets
Senator Elizabeth Warren’s letter to the Fed on the SLR relaxation
A simple explanation of what is the Repo Market
