As you can see from the chart above, usage of the reverse repo facility spiked the day after the Fed raised the rate they would pay on reverse repo transactions by 5 basis points.

In fact, the total increase was 45%, amounting to just about an additional $235 billion – in just one day!

There are two issues to consider here.

First, that reverse repo usage was already very high, at $520 billion on the day of the Fed’s meeting. For context, usage of reverse repo peaked at approximately $300 billion during the height of the market meltdown in March/April 2020.

Also, this reverse repo redux began in April of this year, and started to really pick up steam in May, when the Fed was still paying 0% for reverse repo transactions.

Which brings us to the second issue.

Since the 45% spike in transactions with the Fed happened immediately after the 5 basis points increase, it is reasonable to surmise that this capital was enticed into using the facility by the higher interest rate.

For reference, 1 month UST Bills are yielding slightly less than 5 basis points, 0.0456%, at time of writing.

This implies that the $235 or so billion that poured into the facility was not already tapping overnight reverse repo with the Fed prior to June 16’s Fed meeting. Or, at the very least, a large proportion of the increase can be attributed to capital wanting to earn higher yields.

This includes market participants who now are actively choosing to use the reverse repo facility as an avenue to generate investment returns. 

What does this mean for the $520 billion that was already tapping the facility?

Firstly, and most importantly, it means that pre-existing issues of collateral scarcity have not been solved.

Why?

Simply because, if half a trillion in capital was engaging in reverse repo with the Fed before June 16, then that same half a trillion will still be rolling over reverse repo transactions with the Fed on a daily basis after the 5 basis point increase. 

Putting it another way, if financial institutions were willing to lend to the Fed at 0% in order to obtain USTs, why would they stop doing so at 0.05%?

In fact, at 0.05%, they can get their hands on USTs for use as repo collateral, while earning interest from the Fed as well! It almost sounds too good to be true.

But does this really change anything or alleviate the scarcity in any way?

Unfortunately, the answer is no, simply because the interest that the Fed pays comes in the form of reserves, which do nothing for repo market liquidity.

In other words, the Fed’s 5 basis points fail to address the issue of why $520 billion was already actively using the reverse repo facility.

What happens when this scarcity reaches a tipping point, and participants cannot get hold of the collateral they require?

Global repo contagion, that’s what.