2023-08-14 03:35:29
The Fed’s overnight reverse repurchase instrument — known as the O/N RRP and where money market funds receive money for parking capital overnight — fell to $1.717 trillion on July 18. But since then, it has stabilized at levels closer to $1.8 trillion.
The significance of this is that investors were expected to withdraw cash from the instrument to absorb the large number of Treasury bill issuances that began after the federal debt limit was suspended in early June.
As cash begins to flow out of other segments of the financial system—particularly from bank reserves—to buy Treasury bills, complications may arise.
The Fed’s two key liquid liabilities | Reverse repos usage expected to fall faster than bank reserves
During June, it appeared that about 60% of the net supply of the bills was paid for with cash migrating from reverse repo instruments, RBC strategists Blake Gwinn and Izaac Brook wrote in a report. However, the transfer rate is declining and can settle around 45% and 50%.
In part, this is because money market funds’ appetite for bills is reaching its natural limit, but also, bill yields have become less competitive with the rate of reverse repurchase instruments.
“If O/N RRPs hold close to current levels, stocks should start to fall a little faster in the coming months,” the strategists wrote in an Aug. 10 report.
Reserve shortages have caused problems in the past, most notably in September 2019, when increased Treasury lending exacerbated the reserve shortage created when the Fed stopped buying as many Treasuries for its balance sheet and investors had to take over.
Overnight funding rates for Treasuries soared and the Fed finally stepped in by restarting buying the securities to stabilize the market.
The Fed’s reverse repo instrument outflow has stalled
Since the Federal Reserve is currently in the process of dumping Treasuries and rolling over only a portion of its holdings that come due each month, a process called quantitative tightening, or QT, the prospect of a fall in reserves is considered has the potential to force your hand again.
There is already a widespread expectation that the Fed will stop QT at the point where monetary policy changes course from tightening to easing, the timing of which can only be guessed at. RBC strategists project that to happen by the end of the year, “with risks skewed toward early 2024.”
Bank reserve balances were $3.229 trillion for the week ending Aug. 9, according to data released by the Fed. Unfortunately, no one knows how much that number may drop before banks turn off the spigot. And after the bankruptcy of several regional banks in March, financial institutions seem to be more inclined to keep additional reserves. When the crisis began, the figure was closer to $3 trillion.
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