Impact of Rate Cuts on Securities Lending
January 29, 2025
After aggressively hiking interest rates to a 10-year high of 5.5%, the U.S. Federal Reserve started 2024 in a holding-pattern of sorts. Inflation measures were cooling, but the American consumer was still feeling the pain of high prices. The Fed would hold rates steady until their September meeting, when it would institute a 50-basis point cut, the first cut since Covid. Two more 25-basis point rate cuts would follow in November and December, with analysts forecasting additional cuts, albeit at a slower cadence, in 2025.
Like most financial markets, the Fed funds rate plays an important role in the securities finance industry. Beyond pricing mechanics, the shift to a rate-cutting environment has both short-term and long-term implications for securities lending activity and revenue.
In the Q3 2024 edition of The Purple, we analyzed the impact of rate cuts on short-term cash reinvestment revenue. In summation, when looking at securities lending transactions holistically, lenders have the opportunity to benefit from previously reinvested collateral in longer-dated instruments.
In contrast, the loan leg of a transaction is open as trades are rerated daily, and new loans are executed relative to the updated federal funds rate immediately.
Regulatory regimes such as Basel III require that large financial institutions maintain a certain percentage of high-quality liquid assets (HQLAs) as part of their balance sheets, so along with various funding mechanisms, regulatory requirements can drive demand for instruments like U.S. Treasurys in the securities finance market.
Our data shows that sovereign debt was the only asset class to outperform (+8%) in 2024 vs. 2023. In the U.S., loan balances for Treasurys grew by 14% year-over-year to an average balance of $821 billion. This meant the asset class represented 32% of the industry-wide loan balance, up from 29% in 2023.
Outside of the U.S., Canadian sovereign debt was the next most borrowed, with a balance of $104 billion. French debt rounded out the top three with $77 billion in sovereign bonds on-loan.
Corporate bonds, on the other hand, saw significant cooling in 2024 as a 29% decline in fees across both investment-grade and high-yield issuances led to a 21% decrease in revenue for securities lenders.
The decline in demand was predominantly a result of the declining interest rate environment. During the rate cuts of 2023, corporate bonds benefited from directional trades. In addition, the U.S. corporate bond market saw a 30% year-over-year increase in total issuance value as the falling interest rates made debt a more attractive corporate financing tool.
As the calendar has flipped to 2025, bond yields have climbed nearly 50 basis points in a month as economic policy changes, and the potential for inflationary tariffs, loom large as part of the incoming Trump administration. We will continue to monitor securities lending activity closely as falling rates and rising yields will create an interesting dynamic for the bond market.