Canada’s short-term funding markets are flashing pockets of stress just as the Bank of Canada shifts from shrinking its balance sheet to a steadier, post-QT footing.
The Canadian Overnight Repo Rate Average, a key measure of overnight collateralized funding, has been printing a few basis points above the policy rate for much of September.
Premium is a classic sign that cash and readily available government bond collateral are at a tighter margin than usual, and it has arrived at an awkward moment in the policy transition.
The central bank formally laid out the contours of that transition early this year. It said quantitative tightening would conclude and that business-as-usual asset purchases would resume to keep settlement balances within a stable range and to offset the growth of currency in circulation.
The plan started with a restart of term repo operations in early March, run every two weeks, with initial allotments of 2 to 5 billion Canadian dollars across one- and three-month maturities.
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Treasury-bill purchases are slated to follow to rebuild a more balanced mix of short-dated assets on the Bank’s books, while government bond buying is not expected until later in the process. The shift is designed to prevent the supply of settlement balances from dropping too quickly as legacy pandemic-era holdings mature.
A big test for that approach was always likely to arrive around the large Government of Canada bond maturity that hit on September 1.
The maturity profile of the central bank’s assets means settlement balances can fall sharply when big chunks roll off, even if the broader stance of policy is unchanged. In a January speech mapping out the end of QT, the Bank highlighted that specific maturity and telegraphed the need to bridge the gap with more routine asset operations.
Canadian dealers face balance sheet constraints around reporting dates, and their capacity to intermediate repo flows can get tighter as they manage capital and leverage metrics that can make them less willing to extend overnight funding, especially when hedge-fund basis trades and futures positioning raise demand for cash against government securities.
When that demand collides with a temporary dip in available collateral or a decline in settlement balances, prints above the policy rate become more likely.
Beyond term repos, it runs daily Securities Repo Operations that lend out its holdings of government bonds to primary dealers, which can ease collateral scarcity and improve market functioning.
It can also use overnight repo operations to smooth pressures around month- and quarter-ends. None of these programs changes the policy stance on their own. They are plumbing tools, meant to keep overnight rates trading close to target so the policy signal remains clear.
A consistent premium of only a few basis points will not make or break the economic outlook, but it does ripple through pricing at the very front end of the curve.
It can tug on bill yields, influence CORRA-linked derivatives, and nudge expectations for the path of the policy rate if traders interpret the signals as evidence that the system’s demand for reserves is higher than estimated. It also affects dealer funding costs and balance-sheet capacity, which can feed through to liquidity and bid-ask conditions in cash bonds.
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The Bank revised its estimate of steady-state settlement balances to a range of 50 to 70 billion Canadian dollars after surveying market participants last year, up from a previous 20 to 60 billion range.
That upward shift was rooted in higher precautionary demand for risk-free liquid assets across the system. If the recent premium in overnight funding endures, it will reinforce the case for staying near the higher end of that range while the balance sheet normalizes.
