Global investors are drawn to US fixed income markets, among other reasons, because of the depth of liquidity. The long-term investor, wishing to match assets against liabilities would traditionally purchase US Treasury bonds (T-bonds). This pattern of investment has not changed, but the yield on longer dated Treasuries has become structurally higher than the yield on interest rate swaps (IRS).

In a normally functioning market the lowest yield for a given maturity is usually the yield on government bonds – the so called risk free rate – however, regulatory and monetary policy changes have undermined this relationship.

Writing in March 2016 for Forbes, Darrell Duffie of Stanford University – Why Are Big Banks Offering Less Liquidity To Bond Markets?  described the part of the story which relates to the repo market:-

The new Supplementary Leverage Ratio (SLR) rule changes everything for the repo market. For the largest U.S. banks, the SLR, meant to backstop risk-adjusted capital requirements, now requires 6% capital for all assets, regardless of their risk. For a typical large dealer bank, the SLR is a binding constraint and therefore pushes up the bank’s required equity for a $100 million repo trade by as much as for any other new position of the same gross size, for example a risky real estate loan of $100 million. This means that the bank’s required profit on a repo trade must be in the vicinity of the profit on a risky real estate loan in order for the repo trade to be viable for shareholder value maximization. That profit hurdle has become almost prohibitive for repo intermediation, so banks are providing dramatically less liquidity to the repo market. As a result, the spread between repo rates paid by non-banks and by banks has roughly tripled. The three-month treasury-secured repo rates paid by non-bank dealers are now even higher than three-month unsecured borrowing rates paid by banks, a significant market distortion. Trade volume in the bank-to-non-bank dealer market for U.S. government securities repo is less than half of 2012 levels.