Year-End Turn Pricing in Funding Markets
Short-term funding rates spike over year-end because banks shrink their balance sheets to look better on year-end regulatory reports, and the market prices this predictable squeeze into anything that spans the turn.
Prerequisites: The Fed Funds-SOFR Basis
Banks report their balance sheet size on the last day of the year, and that snapshot feeds into regulatory capital and leverage ratios that carry real costs if a bank looks too large. To shrink their reported footprint, banks pull back from repo lending and other short-term funding activity right around December 31st, even though the pullback is temporary and reverses within days. Because fewer institutions are willing to lend cash secured by collateral over the turn, the overnight rate for borrowing across year-end spikes — sometimes dramatically — even though nothing has changed about underlying credit or collateral quality.
This "turn effect" is predictable enough that markets price it in advance: a term repo trade or FX swap that happens to span December 31st will trade at a materially different rate than an equivalent trade that starts a few days later and avoids the turn entirely.
Year-end funding spikes come from balance-sheet window-dressing by banks around regulatory reporting dates, not from any change in credit risk, and the market prices the spike into any trade that spans the turn.
A one-week repo trade starting December 28th might price at an annualized rate several percentage points above a one-week trade starting January 2nd, purely because the first trade's week includes the year-end date and the second one's doesn't.
Practice in interviews
Further reading
- Federal Reserve Bank of New York, staff reports on year-end repo dynamics