Rationalization: How extra liquidity manifests in US cash markets and reverse repurchase agreements

An eagle looms over the facade of the US Federal Reserve constructing in Washington, July 31, 2013. REUTERS / Jonathan Ernst / File Picture

NEW YORK, July 2 (Reuters) – The US debt ceiling got here again into impact on the finish of July, placing stress on the Treasury to cut back its money place earlier than maturity. This implies extra injections of liquidity right into a monetary system that’s already overflowing with liquidity, which might decrease short-term charges and trigger undue distortion in cash markets.

Practically a file trillion {dollars} in money poured into the Federal Reserve’s reverse repurchase facility (RRP) on Wednesday.

On Thursday and Friday, reverse repo volumes peaked at $ 742.6 billion and $ 731.5 billion, respectively.

The file quantity got here after the Fed final month made a technical adjustment to the rates of interest it manages, elevating the speed paid by banks on extra reserves (IOER) held on the Fed to 0, 15% towards 0.10% and the speed paid on reverse repo at 0.10% 0.05% from zero.

WHAT IS THE FED REPO REPO WINDOW?

The Fed launched its reverse repo program (RRP) in 2013 to mop up further liquidity within the repo market and create a tough ground under its key price, or the efficient federal funds price, presently in a goal vary of 0. % to 0.25%. Eligible counterparties lend liquidity to the Fed in alternate for in a single day Treasury ensures.

WHAT IS THE RELATIONSHIP BETWEEN THE CASH VOLUME AND THE DEBT CEILING?

The market is dealing with extra liquidity within the banking system as a result of Fed’s asset purchases as a part of quantitative easing and the US Treasury’s monetary help to the financial system in response to the pandemic.

The US Treasury should scale back its money stability within the Common Treasury Account (TGA) deposited with the Fed to a goal of $ 450 billion earlier than a two-year debt ceiling suspension expires on July 31. learn extra As of June 29, the Treasury has a money stability of $ 711 billion, in accordance with Wrightson ICAP knowledge.

A discount within the TGA will increase the reserves of the banking system, which are actually paid into the RRP market.

IS REPO REPO VOLUME GROWTH A CONCERN?

Rising RRP charges might scale back the demand by cash market funds for US Treasuries, because the charges for the latter are at their lowest. For instance, 3-month US Treasury invoice charges are presently hovering under 0.05%.

Zoltan Pozsar, world head of short-term rate of interest technique at Credit score Suisse, mentioned the rotation of invoices to RRPs won’t occur rapidly as a result of invoices are presently underwater, which implies they’re underwater. can solely be offered at a loss.

“However it’s going to occur that it’ll,” he mentioned.

Traders are additionally watching whether or not the quantity of reserves and deposits that banks might lose to the RRP facility might be giant sufficient to disrupt the dynamics of the rate of interest market.

Lou Crandall, chief economist at Wrightson, believes financial institution money outflows should not but an issue.

If banks are anxious about seeing extreme money outflows as a result of cash market funds can earn 0.05% with the RRP facility, they’ll match that price to carry their deposits, he mentioned.

Reporting by Gertrude Chavez-Dreyfuss; Modifying by Alden Bentley and Andrea Ricci

Our requirements: Thomson Reuters Belief Ideas.

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