Treasuries Pare Gains as Financing Rates Rebound

Y2K-related volatility in the money markets made Treasuries appealing in the morning, less so in the afternoon.
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Treasury prices rose again today, but closed off their highs after short-term financing rates -- which had declined to super-low levels during the first half of the trading session -- returned to more normal levels. Still, yields improved to their best levels in a week or more.

Financing rates are the rates at which professional traders borrow the money that they then invest in Treasury and other debt securities. The

fed funds rate

is the benchmark financing rate.

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Financing rates have declined to very low levels, at least on an intraday basis, in the past few trading sessions as the


has taken measures to ensure that anyone who wants to withdraw a fat wad of cash from the bank for the Y2K weekend can do so. Specifically, the Fed has conducted ordinary

open market operations

to an extraordinary degree.

In open market operations, the Fed keeps the fed funds rate on target by supplying as much bank reserves as there is demand for at that price, by buying government securities from dealers on either a permanent or temporary basis.

Most of the Fed's recent operations have been temporary. This kind of operation is called a repurchase agreement: The Fed buys securities from dealers, with an agreement that the dealers will repurchase them on a certain date.

With its latest, $7.6 billion repurchase agreement this morning, the Fed brought the total amount of repurchase agreements it has outstanding over the turn of the year into the neighborhood of $125 billion.

For at least the third time this week, the Fed oversupplied the banking system with liquidity. With more bank reserves available for lending than there was demand, the fed funds rate went significantly below the Fed's 5.5% target for it, trading as low as 3.5%.

The drop in the fed funds rate pulled repo rates lower as well. Repo rates are the rates at which professional traders and investors borrow from dealers to finance purchases of securities, and they generally hover 5 to 10 basis points below the fed funds rate, because a repo loan is collateralized by the securities the funds are used to purchase. (A fed funds loan, by contrast, is uncollateralized.) Overnight Treasury repo (a repo loan used to finance the purchase of a Treasury security) traded at a low in the neighborhood of 2%.

The drop in financing rates boosted purchases of Treasuries early in the session, helping the benchmark 30-year Treasury bond gain as much as 11/32 at one point.

"People got excited about that early on," said Tom Connor, head government bond trader at

J.P. Morgan

. "There was some early buying and everything traded better."

But then financing rates corrected over the course of the session. Overcorrected, actually. The fed funds rate finished the day over the Fed's target at 6.50%, and overnight repo ended at 5.40%. Treasuries pared their gains, the long bond ending up 7/32 at 96 1/32, trimming its yield 1.7 basis points to 6.426%.

There was no other driving force in Treasuries today. The day's

economic releases afforded no big surprises, and volume was characteristically low for one of the last trading days of the year. Tracker


logged $29.5 billion, the vast majority in bills or two-year notes, 15.7% less than average for a Thursday over the past month.