By Gertrude Chavez-Dreyfuss
NEW YORK (Reuters) – Cash-filled financial institutions flocked to the Federal Reserve’s repurchase facility (RRP), lending money to the U.S. central bank at a 0% interest rate and raising concerns in the bond market that key short-term interest rates could indeed fall below zero.
According to data from the New York Fed, the volume of the Fed’s overnight reverse repo window jumped to $ 433 billion on Tuesday. Analysts said it was the third largest use of all time, with the largest being $ 474.6 billion as of Dec.31, 2015.
Just over two months ago, around mid-March, there was no reverse repurchase activity.
Scott Skyrm, executive vice president of fixed income and repo at Curvature Securities, said that “the volumes are so huge in a period without month-end and quarter-end tells me this is about market distortion ”.
“Overall, this suggests to me that quantitative easing is being done and that the Fed needs to cut back on its purchases” or cut back on its purchases of US Treasuries and other debt assets.
The market is grappling with a glut of liquidity in the system, mainly thanks to the Fed’s asset purchases and the US Treasury’s financial support to the economy in response to the coronavirus pandemic.
This put pressure on initial interest rates, with some overnight repo rates periodically turning negative this year. On Monday, the overnight repo rate fell to -0.01%, the lowest since late March, but recovered to 0.02% on Tuesday.
The Fed launched its reverse repo program in 2013 to absorb additional liquidity in the repo market and create a hard floor below market rates, especially its policy rate. Eligible counterparties lend liquidity to the Fed in exchange for overnight Treasury guarantees.
At this year’s March policy meeting, the Fed raised the amount that counterparties can lend to $ 80 billion, from $ 30 billion.
Along with other deposits, the Fed drained more than $ 500 billion a day in bank reserves, according to Barclays.
“The fact that the balances of these programs are swelling is an indication that money market funds, non-U.S. Official institutions and state-owned enterprises are struggling to find assets with returns above 0%,” said Joseph Abate, managing director. fixed income research. to Barclays in a research note.
“And as their cash holdings grow, they have few investment options outside of the Fed’s balance sheet.”
Gennadiy Goldberg, senior rate strategist, TD Securities, said so far the facility has been operating as expected, “like a relief valve for excess cash.”
Without the reverse repo activity, “money market rates such as the SOFR (US Guaranteed Overnight Funding Rate) would be under downward pressure, possibly below zero,” he said. he added.
SOFR, an overnight repo rate that will replace Libor as the benchmark rate, remained stuck at 1 basis point. The effective federal funds rate, the rate that banks charge each other for overnight loans to meet the reserves required by the U.S. central bank, is currently 6 basis points, while Treasury bill yields with maturities beyond July are 0% or barely above.
Some market participants expect the Fed to increase the reverse repo rate and interest on excess reserves (IOER), currently at 0.10%, two rates that influence overnight fed funds. to trade within the target range.
This should reduce the pressure on the banknote and repo markets.
(Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley)