(Bloomberg) -- Delivery fails involving 10-year Treasury notes surged to the highest level in eight years this month, a result of the Federal Reserve's move to shrink its bond portfolio since 2022.
Trades involving the most recently issued 10-year note that failed to settle on schedule totaled $30.5 billion during the week ended Dec. 10, the most since December 2017, recent data from the New York Fed show.
Fails that week occurred amid a collapse in interest rates available to owners of the newest 10-year note, which was created via a $42 billion auction on Nov. 12. Holders willing to lend the note were able to do so at negative interest rates, with borrowers of the issue agreeing to sell it back the next day for less than they paid — a circumstance in which settlement failures are more likely to occur.
While it's not unusual for Treasury securities to command "special" rates in repurchase agreements ahead of a reopening auction that increases their supply, the shortage ahead of the 10-year note reopening that settled on Dec. 15 was out of the ordinary. It stemmed in part from the smaller portion of the November auction — relative to 10-year notes sold earlier in the year — owned by the Federal Reserve, which makes its securities available to borrow.
"There's just less available to borrow," said Jason Schuit, president of South Street Securities, a broker-dealer that specializes in Treasury repo. "For this particular 10-year note, the Fed bought half of what it did in the previous three cycles. That caused a supply shortage, which causes delivery fails," he said. In the November 10-year note auction, $42 billion was sold to investors and the Fed requested an additional $6.5 billion for its account to replace maturing debt.
In previous quarterly auctions of new 10-year notes, the Fed's add-ons to the same $42 billion private-market totals were $11.5 billion in February, $14.8 billion in May and $14.3 billion in August. Those amounts are a function of the quantity of Treasury securities that mature from the Fed's System Open Market Account holdings, which totaled just under $22 billion for Nov. 15 compared with amounts ranging from $45 billion to $49 billion for Feb. 15, May 15 and Aug. 15.
The drop-off in the amount of SOMA holdings occurred because the Fed in mid-2022 began reinvesting its maturing Treasuries only to the extent that they exceeded a monthly cap, which increased to $60 billion a month in September from $30 billion a month in June. As a result, the Fed's add-on in November to the auction of three-year notes that matured this year declined relative to previous quarters, requiring smaller add-ons to last month's auctions.
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