Money markets 7yr notes are still hard to get in repo market

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* Specials in 5yr and 7yr notes could last to Feb 29 * More demand for 7yr notes in hedges, futures trades * Repo traders still divided on cause of 7yr special By Emily Flitter NEW YORK, Feb 22 The heavy premium on five- and seven-year Treasury notes as overnight repo collateral could last for the rest of the month, until new five- and seven-year notes enter the marketplace in auction settlements on Feb. 29. Repo market participants were still scrambling on Wednesday to find seven-year notes and those who did paid a dear price. The rate on seven-year repo collateral was around -200 basis points, according to Jefferies, just 100 basis points above the penalty cost of a failure to deliver a Treasury security in the repo market. Repo market participants trade cash for securities, including Treasuries, in short-term loans. Some repo participants need the cash; others need the securities more than the cash and end up paying a premium to obtain them. The securities to which a cost is attached are said to "trade special." "I think it kind of feeds on itself," said Tom Simons, money-market economist at Jefferies & Co. in New York, referring to the specials in five year notes and seven year notes. "Since the rates are where they are it makes sense for people who are holding them to keep holding them until the people who need them get even more desperate." The Treasury Department's auctions of five-year notes and seven-year notes this week are set to settle at the end of the month. Strong demand at Wednesday's $35 billion sale of five-year notes could be seen again at Thursday's $29 billion seven-year note auction, based on the similar repo collateral conditions for the two Treasury maturities. A definitive reason for the specials remained elusive on Wednesday. "That part of the curve has gotten really rich so you could have a bigger short base and there's less available to buy," said Ira Jersey, interest-rate strategist at Credit Suisse in New York. Seven-year notes are in more demand now for use in hedges against mortgage duration risk, as well as in Treasury futures contracts, Jersey added. Meanwhile, a flood of European Central Bank cash may not be sufficient to unblock market funding channels for most euro zone banks struggling to reduce exposure to risky assets while a flare up in the sovereign debt crisis remains a threat. The ECB's first offering of almost half a trillion euros in cheap, three-year funds at the end of last year and the prospect of a similar take-up at a second tender on Feb. 29 have been hailed as removing the risk of a major credit crunch and a chain of bank failures across the euro zone. But the extra ECB cash has so far not persuaded lenders to introduce new credit lines or significantly extend the length of their existing funding agreements. Weak banks remain frozen out of money markets while the strong fear exposure to risky peers. A marked pick-up in banks' ability to borrow money in the market - whether from other banks or money market funds - would encourage them to fund businesses and households, helping heavily indebted economies such as Italy and Spain grow. Access to market cash is mostly restricted to a select group of highly-rated banks in the heart of Europe, such as Germany's Deutsche, Rabobank of the Netherlands and national champions in southern states, such as Spain's Banco Santander, traders say. Weaker banks, often exposed to riskier euro zone debt or other toxic assets such as bad mortgage loans, depend on the ECB for funds. Analysts say this is unlikely to change as the threat remains that Greece may not be the last euro zone state to restructure its debts.