Clarification: How extra liquidity happens in cash markets and reverse repurchase agreements in the USA

NEW YORK (Reuters) – The US debt ceiling returns in impact on the finish of July, placing stress on the Treasury to scale back its money stream 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.

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

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

The document 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% in opposition to 0.10% and rising the speed paid on repurchase agreements to 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 extra liquidity within the repo market and create a tough ground under its key charge, or the efficient federal funds charge, presently in a goal vary of 0. % to 0.25%. Eligible counterparties lend liquidity to the Fed in change for in a single day Treasury ensures.

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

The market is going through extra liquidity within the banking system because of the Fed’s asset purchases as a part of quantitative easing and the US Treasury’s monetary assist to the financial system in response to the pandemic.

The US Treasury should cut back its money steadiness within the Normal 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. As of June 29, the Treasury has a money steadiness of $ 711 billion, in keeping with Wrightson ICAP knowledge.

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

Chart: US Treasury money steadiness – https://fingfx.thomsonreuters.com/gfx/mkt/yxmpjaqrkvr/USpercent20Treasurypercent20cashpercent20balance.PNG

IS REPO REPO VOLUME GROWTH A CONCERN?

Elevating RRP charges might cut back the demand of 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, stated the rotation of invoices to RRPs is not going to occur shortly as a result of invoices are presently underwater, which suggests they’re underwater. can solely be offered at a loss.

“However it would occur that it’s going to,” he stated.

Traders are additionally watching whether or not the quantity of reserves and deposits that banks might lose to the RRP facility may very well be massive 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 charge to carry their deposits, he stated.

(Reporting by Gertrude Chavez-Dreyfuss; Enhancing by Alden Bentley and Andrea Ricci)

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