Money markets us bill supply may support repo rates rbc

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* Rise in US repo rates may compress short-term swap spreads * High yield in 3-month bill sale rises on the week * ECB injection could worsen shortage of Spanish bonds in repo By Chris Reese and Emelia Sithole-Matarise NEW YORK/LONDON, July 13 The interest rate on U.S. repurchase agreements is likely to be supported in coming weeks as the supply of Treasury bills rises, which could in turn compress shorter-dated interest rate swap spreads, according to a strategist at RBC Capital Markets. A recent narrowing of shorter-dated swap spreads may be related to changing expectations for repo rates, said Michael Cloherty, head of U.S. interest rates strategy at RBC in New York. "In the upcoming weeks, a rise in bill supply is likely to keep repo elevated," Cloherty said, noting that "repo rates are highly dependent on bill supply, and bill supply is highly seasonal. "August tends to be one of the months where issuance is high, and we will see an above-average rise in bill supply this month," Cloherty said. The rate on repos secured by Treasuries dipped to 0.22 percent o n M onday from 0.25 percent o n F riday. Repo rates have generally been trending higher since touching a recent low of 0.03 percent over a year ago. Meanwhile, the spread on two-year interest rate swaps over Treasuries narrowed to 19.75 basis points o n Mo nday from 20.5 basis points on Fr iday. The two-year swap spread has generally been narrowing since hitting a recent wide of 54.5 in November, 2011. The U.S. Treasury on Monday auctioned $32 billion of 3-month bills at a high rate of 0.11 percent, up slightly from a high rate of 0.1 percent in a similar auction last week and matching the high rate in an auction two weeks ago. An auction of $28 billion of 6-month bills on Monday brought a high rate of 0.145 percent, up from a high rate of 0.135 percent in a similar auction last week and matching the high rate from an auction two weeks ago. Meanwhile, in Europe, a fresh injection of long-term ECB loans into the banking system could worsen a shortage of Spanish government bonds in the repo market, further squeezing a source of short-term funds for Spain's banks. Traders said a distortion of prices in the Spanish repo market that followed a 1 trillion euro flood of three-year European Central Bank loans in December and February could be exacerbated if the bank repeated the operation. Spanish government bonds have been in short supply in the repo market, where banks commonly use them as collateral to raise funds, since domestic banks parked them at the ECB in return for cash -- particularly the three-year loans. This prompted investors who need the bonds because of their own short positions to pay a premium for the paper. In a normal repo operation, the party needing the cash would pay the premium, but in the distorted Spanish market, it is the other way around. "In Spain there are a lot of short positions in the market ... and we're seeing the repo levels around -3 or -4 percent," a repo market trader said. A negative number means the borrower is effectively being paid to take the lender's cash. "As soon as the repo market gets to be like that, it stops functioning effectively and that has a knock-on effect in the cash market because you can't provide liquidity to clients," the trader said. ECB President Mario Draghi said earlier this month the ECB would discuss loosening its collateral rules further in September and could repeat other measures such as its long-term cheap loans, known as LTROs. "Perversely if another LTRO came in and there was a big take-up by Spanish banks and they put Spanish bonds in, the repo market could get worse," another trader said. "This is contributing to the decline of the cash market because you need the repo to oil the wheels in the cash market." Banks can repay the ECB's initial three-year loans after 12 months. But as the three-year-old sovereign debt crisis rumbles on with Spain now on the front line, analysts expect reliance by peripheral banks on the central bank to remain high. Spanish banks' reliance on ECB loans has increased in recent months, as it has for Italian banks. But unlike Spain, the Italian repo market is still functioning normally, supported by the deeper liquidity in the country's debt market.

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