It was remarkably resilient repo wot won it

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How bad was the Treasury market turbulence last month? It was “real and significant” and “unnerving”, but it wasn’t chaotic or even “exceptional” — thanks largely to funding markets remaining remarkably durable.

That’s the conclusion of Roberto Perli, the manager of the New York Federal Reserve’s System Open Market Account, who gave an interesting speech on the subject today.

A word of warning. This was initially supposed to be a quick write-up of a speech on a timely topic, but soon became a bit of an opus. If things like IORB, MMFs, ON RRP and SRF make you want to self-harm, then please leave and enjoy your weekend. But this stuff is pretty important — and interesting! — so we hope you stick around.

As you may have read here and elsewhere, Treasuries went a bit weird last month, sinking alongside everything else. No one likes that. After all, Treasuries are supposed to be the world’s best haven when everything else is looking sickly.

However, as Perli noted, while the US government bond market’s liquidity deteriorated sharply in mid-April, it still continued to function. That is a sharp contrast to what we saw in March 2020, when the Treasury market nearly completely froze.

This is obviously largely because Covid-19 was a far bigger economic and financial shock than President Donald Trump’s “liberation day”. But it is also just as much because “funding liquidity remained plentiful”, according to Perli:

.?.?. Although liquidity in Treasury cash markets became strained in early April, those markets continued to function, in part because of the resilience of funding liquidity in the Treasury repo market. That resilience, even amid heightened yield volatility, likely prevented the unwind of certain shorter-term relative value trades, which would have exacerbated market dislocations. And funding liquidity resilience was likely helped by the robust rate control framework that the Federal Reserve has put in place.

For example, although Perli reckons the swaps spread trade unwind had a big impact on Treasuries, he argues that the now-infamous basis trade was the dog that didn’t really bark.

While the Treasury basis trade stood at an estimated $1tn at the end of March 2025 — much bigger than when it caused carnage in March 2020 — there was no massive forced unwind this time because repo markets remained calm:

One factor that could lead to a rapid unwind of the basis trade is substantial repo rate volatility or a persistent increase in repo rates, which could in turn increase the cost of financing the position and therefore make it unprofitable. But this by and large did not happen in April since repo rates were fairly stable and dealers remained willing and able to intermediate. As a result, according to Desk staff’s estimates, the basis remained relatively stable. This stands in sharp contrast to March 2020, when the basis jumped by about 100 basis points and the unwinding of basis trades was likely an important contributor to the sharp dislocation in the Treasury market we observed at that time.

Here we want to shoot in a pedantic point, because the pendulum has probably swung too far from blaming the basis trade for every ill that afflicts markets to exonerating it completely from absolutely everything.

Just because repo markets were resilient and the basis between cash Treasuries and Treasury futures remained reasonably stable, it doesn’t necessarily mean that at least some hedge funds didn’t ratchet back their basis trades when volatility spiked. Alphaville knows of at least one hedge fund that pretty much got out of the trade in early April, and has heard enough colour from prime dealers and buyside traders to conclude that there really were some chunky basis trade unwinding going on. It was just controlled and orderly.

Anyway, Perli rightly points out that this shows just how vitally important short-term funding markets are to the US government bond market, because of the growing importance of highly leveraged hedge fund strategies.

When funding liquidity remains stable, as it did in early April, it is less likely that a deterioration of market liquidity will spiral into market dysfunction. This is because market participants can still finance their transactions, and arbitrage does not break down. In other words, because of the widespread presence of leveraged investors in the Treasury market, funding liquidity reinforces market liquidity.

So what does this all mean? Well, the Federal Reserve’s toolkit to influence money markets is even more important these days. Or as Perli puts it:

Funding liquidity is more likely to remain plentiful if money market rates are not too volatile, which, in turn, depends on the availability and efficacy of monetary policy implementation tools for ensuring rate control within the Federal Reserve’s ample reserves framework.

One of those tools is the overnight reverse repo facility — or ON RRP among friends. ON RRP allows money market funds and other important short-term funding market players to park money at the Fed. It is (along with interest on reserve balances), one of the main tools used to control interest rates in the abundant reserve era.

But the main one that Perli discussed today was a newer one called the Standing Repo Facility. This is a permanent and powerful programme that lets banks use Treasuries and agency debt as collateral for short-term loans, and came after a big repo blow-up in 2019.

Although priced a little higher than where the Fed sets interest rates, there’s less of a stigma attached than hitting up the discount window. And because banks can also use the facility on behalf of clients, such as money market funds, it’s a great way of dampening repo market pressures.

Perli’s team now wants to strengthen the SRF to make sure it can continue to ensure that funding markets remain well-behaved. In March, the NY Fed began testing early morning settlements alongside the existing afternoon settlements, and these seem to have gone well:

Our market outreach following the March quarter-end revealed that primary dealers see the early-settlement SRF operations as an enhancement that increases the likelihood that the SRF will be used when economically convenient to do so. This is especially true for non-U.S.-bank-affiliated primary dealers, though this group is relatively small and accounts for only about a tenth of primary dealer repo borrowing. Dealers also reported that early settlement lowers hurdle rates — that is, the rate in excess of the SRF rate they are willing to pay in the market before choosing to access the SRF.

This is all encouraging feedback. Based on it, the Desk plans on making early-settlement SRF auctions part of the regular SRF daily schedule, at some point in the not-too-distant future. These early-settlement auctions, combined with the current afternoon auctions, will enhance the effectiveness of the SRF as a tool for monetary policy implementation and market functioning.

That’s all good stuff, but tbqh?Alphaville doesn’t feel entirely comforted by the fact that the health of the world’s biggest and most systemic market increasingly rests on short-term funding conditions, given how fickle money markets can be.

We also have some very specific issues with the SRF — but that will have to be a matter for a future post.

Further reading:
— How the Treasury market got hooked on hedge fund leverage (FT)
— Recent Developments in Treasury Market Liquidity and Funding Conditions (NYFRB)