What You Need To Know About The Fed’s Reverse Repo 1
Wednesday’s FOMC minutes revealed something startling.
Staff at the Federal Reserve reported that takeup of their Overnight Reverse Repo Facility reached $100 billion. Except that this was for their meeting at the end of April.
Now, about three weeks later, takeup has reached almost $300 billion!
Why the sudden and dramatic increase?
Before we can answer that question, we need to first establish what a reverse repo transaction is.
Simply put, reverse repo is the opposite of a repurchase (repo) transaction. Instead of a party selling collateral to buy it back (repurchase it), the party is now purchasing collateral to sell it back.
That is, if a bank is selling US Treasuries in an agreement to repurchase them at a later date, the bank has entered into a repurchase agreement.
If the bank is buying US Treasuries in an agreement to sell them back at a later date, it has entered into a reverse repurchase agreement.
In the context of the Fed’s Overnight (o/n) Reverse Repo transactions, the Fed is selling its USTs to an eligible counterparty, hence the Fed enters into a repo transaction.
The eligible counterparties, on the other hand, enter into a reverse repo transaction with the Fed.
As you can see, the transaction only consists of an exchange of cash for collateral between two parties. Whether a party is considered to be in repo or reverse repo is a matter of which side of the transaction it sits on.
Now, looking at the chart above, we can see two massive spikes in usage of the Fed’s o/n reverse repo facility.
The first was in March/April 2020, which was the financial panic that ensued as the world first entered into Covid lockdowns; firmly in the market’s rearview mirror now.
The second spike, however, is happening in real time – now.
When it was first observed by the Fed in April, demand for the Fed’s USTs stood at $100 bn. That has now tripled, over the course of about three weeks (as of time of writing).
That’s a lot of demand in a very short period of time.
There are two different ways of interpreting this spike in demand for the Fed’s o/n reverse repo facility. One is that banks have too many reserves and are using the overnight reverse repo facility with the Fed as a means to manage their bank reserves better.
This makes sense since banks use reserves in the reverse repo transaction, which takes them off their balance sheets momentarily.
While this is a completely valid explanation, and probably does account for some of the sharp rise in o/n reverse repo since US banks are stuffed full of reserves, and have been for the last decade; there just hasn’t been a drastic enough change in this space to cause such a dramatic spike in o/n reverse repo.
To be concluded…
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