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Short-Selling and Short-Term Interest Rates

Posted By John Schroy On 11th February 2006 @ 11:51 In Treasuries, Open Market, Corporate Bonds | Comments Disabled

As mentioned in the article, “[1] Just What Are ‘Funding Corporations’?“, cash that serves as collateral for securities lending operations is invested in open market paper.

(See: “[2] Funding Corporations Are Major Buyers of Open Market Paper: Q3 2005“).

In Q3 2005, Securities Loaned, at an annual rate, reached an all-time high, as the graph shows:

(Source: Flow of Funds Table F.131 Funding Corporations).

Increase in Securities Loaned
Increase in Securities Loaned

Collateral For Short-Sales Goes Into Open Market Paper

A  large part of securities loaned is related to financing short-sales of stocks and bonds.

Since the data doesn’t indicate what kind of securities were shorted, we can’t say whether this short-selling reflects pessimism about stocks or bonds, and if bonds, whether short-term or long-term instruments.

What we do know, however, is that the cash collateral for short-selling is invested in short-term fixed interest securities (which would tend to increase short-term yields), and that securities that are sold short must be eventually re-purchased (which would tend to increase the future price of securities shorted.)

As the old Wall Street adage goes:

“He that sells what isn’t hisn, must buy them back or go to prison.”

The net volume of securities loaned in Q3 2005, as an annual rate, was $322.8 billion, which is not trivial. To put this in perspective, in the same quarter, net borrowing by the Federal Government (annual rate) was $231.9 billion and by Nonfinancial Corporate Business, $362.2 billion. (Federal Reserve Flow of Funds Table F.1).

We do know that there were expectations in Q3 2005 that long interest rates would rise (and long bond prices fall), and this might explain a flurry of short-selling. If this is the explanation, it would mean that eventually the play would unwind: money would come out of short-term paper (as collateral is withdrawn) and would be put back into long-bonds (to cover short positions). This could help to adjust the dreaded ‘inverted yield curve’.

(See: “[3] Inverted Yield Curves and Logical Traps“)

Tags: [4] bond market, [5] cash collateral, [6] securities lending, [7] short selling
 
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URL to article: http://capital-flow-analysis.com/capital-flow-watch/short-selling-and-short-term-interest-rates.html

URLs in this post:
[1] Just What Are ‘Funding Corporations’?: http://capital-flow-analysis.info/capital-flow-watch/archives/69
[2] Funding Corporations Are Major Buyers of Open Market Paper: Q3 2005: http://capital-flow-analysis.info/capital-flow-watch/archives/67
[3] Inverted Yield Curves and Logical Traps: http://capital-flow-analysis.info/capital-flow-watch/archives/70
[4] bond market: http://capital-flow-analysis.com/capital-flow-watch/index.php?tag=bond-market
[5] cash collateral: http://capital-flow-analysis.com/capital-flow-watch/index.php?tag=cash-collateral
[6] securities lending: http://capital-flow-analysis.com/capital-flow-watch/index.php?tag=securities-lending
[7] short selling: http://capital-flow-analysis.com/capital-flow-watch/index.php?tag=short-selling
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