What does the Fed’s overnight reverse repurchase volume fall below $1 trillion for the first time in two years?Provider Finance Association

Financial Associated Press News on November 10 (Editor Xiaoxiang)As the U.S. government engages in aggressive debt issuance, money market funds gradually invest excess funds into U.S. government bonds, and the use of an important Federal Reserve financial instrument has fallen below the $1 trillion mark for the first time since late summer 2021.

On Thursday, 94 counterparties (money market funds and other eligible firms) parked a total of $993 billion in the Fed’s overnight reverse repurchase agreement (RRP) facility. This is the first time since August 10, 2021 that the usage of the overnight reverse repurchase facility has fallen below the $1 trillion mark.

After reaching a record peak of $2.554 trillion on December 30, 2022, funds have continued to flow out of the mechanism in recent months.

The Fed’s reverse repurchase facility is part of the Fed’s interest rate control toolkit and is designed to provide a floor for short-term interest rates to ensure that the Fed maintains control over the federal funds rate, which is the Fed’s main lever to influence the direction of the economy. The current RRP rate is 5.3%, while the federal funds target rate range is 5.25% to 5.5%.

Many market participants and central bankers previously viewed the popularity of reverse repurchase facilities as a sign of excess liquidity in the financial system.

When the Federal Reserve bought massive amounts of bonds to provide stimulus during the coronavirus pandemic, inflows to the reverse repo facility expanded rapidly, rising sharply from almost zero in the spring of 2021.

Last year, the Fed began shrinking its balance sheet, allowing nearly $100 billion in monthly bonds it holds to mature as part of its efforts to unwind monetary easing. The Fed has so far cut about $1 trillion from its bond portfolio.

Is liquidity starting to tighten due to massive bond issuance?

In the first half of this year, the use of the Fed’s overnight reverse repurchase facility has remained above $2 trillion per day.butSince June, the U.S. Treasury Department has flooded the market with new paper, encouraging funds to move away from reverse repurchase facilities., as the U.S. government has struggled to fill TGA accounts after Congress agreed to raise the U.S. debt ceiling. As the funds in the TGA account continue to rise, the Fed’s reverse repurchase balance is exhausted little by little.

The outflow from reverse repo facilities comes as companies can now invest in private securities at better returns, while a surge in Treasury issuance is drawing their attention away from products offered by central banks. Higher yields on short-term debt have made money market mutual funds more attractive to investors, especially as rates on competing products such as bank deposits have failed to keep pace with interest rate movements.

JPMorgan economists said Thursday that reverse repo use “should decline further” given the issuance of Treasury bonds.

Deutsche Bank strategist Steven Zeng also pointed out, “This is a big change, and with traders holding so many new bonds, the use of the Fed’s overnight reverse repurchase agreement should fall further.”

andAs use of the overnight reverse repurchase facility tapers off, Wall Street strategists are weighing whether it will have further implications for the Fed’s monetary policy, particularly its balance sheet reduction process.

Some strategists say the Fed will have to stop its quantitative tightening (QT) program if demand falls to zero, as excess liquidity will be completely exhausted and bank reserves will become scarce.

Some central bankers and market participants have also leaned toward the view in the near term that when reverse repo facilities are essentially depleted, or at least much lower than they are now, overall financial sector liquidity will be tight enough that the Fed can at least start considering Slow down the table shrinking process or even stop it completely.

However, economists at JPMorgan Chase said that it is currently unlikely that the balance sheet reduction process will end prematurely, and this process may continue until the end of 2024. They estimate that the reverse repurchase level will still be US$700 billion by then.