A key artery in global financial markets can tell the Federal Reserve enough is enough.
Demand for overnight funding through the Federal Reserve Bank of New York’s reverse repurchase program (RRP) has started to flirt with recent highs, after hardly anyone has used it for months. .
Daily use of the repo rose to $ 394.94 billion Monday after surpassing $ 369 billion on Friday, its highest level since late June 2017, according to Tradeweb data.
The Fed’s reverse repo program allows qualifying companies, like banks and money market mutual funds, to park large amounts of liquidity overnight at the Fed in exchange for a small return, which recently fell to around 0.06%.
The program had virtually no clients at the start of April, and few since the pandemic began last spring, but daily demand in recent weeks has increased dramatically. This chart shows the peak in reverse repo demand since April 1.
“Why are they going to the Fed?” Scott Skyrm, executive vice president of fixed income and repo at Curvature Securities, asked about companies wanting reverse repo funding, despite its declining returns.
“Either there is too much cash or not enough collateral,” he told MarketWatch. “These are two sides of the same coin.”
It’s also pretty much the opposite of what happened in September 2019, when repo rates suddenly exploded, prompting the Fed to launch with a series of short-term emergency lending facilities. which helped to calm fears that the financial markets would otherwise freeze.
This time around, Skyrm sees strong demand for the Fed’s low-yielding reverse repurchase facility as a sign that the central bank’s roughly $ 120 billion monthly bond purchase program, no longer works as expected by adding liquidity to financial markets, and should be reduced.
“Right now, the more money you invest, the more you get back,” he said. “The market says ‘It’s time’. There is evidence that QE has gone too far. “
This chart shows the recent spike in reverse repo at the Fed as approaching the highs of the past decade.
The Fed, under President Jerome Powell, has bought $ 2.5 trillion in bonds since the outbreak of the pandemic last year, through its monthly purchases of TMUBMUSD10Y U.S. Treasuries,
and agency mortgage bonds, or “Quantitative Easing” (QE).
“It adds liquidity to the system. As the Fed buys bonds, these sellers receive liquidity and probably buy other bonds or other products, ”Padhraic Garvey, global head of debt and rates strategy at ING, wrote on Monday.
“The point is, liquidity is being placed here because there is nowhere else to go,” Garvey wrote of the Fed’s reverse repurchase program. “And that’s not really where you want to park your money, given that the rate paid to the lender in cash is 0%.”
Overnight repo rates have fallen to the lower end of the Fed’s target policy rates, currently in the zero to 0.25% range.
As MarketWatch reported in April, the concern is that the US central bank is on the verge of losing control over its benchmark policy rates, without making further adjustments to stabilize rates.
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Meanwhile, Powell has promised “great transparency” around the Fed’s possible exit from easy monetary policies. Several Fed officials recently called on the central bank to start discussing a slowdown in its bond purchases, while the latest minutes from the rate-setting committee meeting showed a willingness to explore the topic. at future meetings.
A BTIG research team led by Julian Emanuel described the situation as a game of cat and mouse.
Strong demand for the Fed facility “underscores the pressures on the short end of the yield curve as short-term rates probe negative territory after more than a year of extraordinary accommodative policy,” wrote the team in a Sunday note.
But they also expect the issue to last “until investors are confident enough to switch to longer-dated bonds,” which shouldn’t happen until the markets have more. clarity on the Fed’s plans to reduce its bond purchases.