The amount of money parked in the Federal Reserve’s overnight reverse repurchase agreement (RRP) facility fell below $100 billion for the first time since 2021, following a recent policy adjustment by the central bank. This significant drop signals a shift in the financial landscape and warrants closer examination by investors.
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On Friday, approximately 40 participants placed a combined $98.4 billion in the RRP, a facility utilized by banks, government-sponsored enterprises, and money market mutual funds to earn interest. This marks a dramatic decrease from the record $2.55 trillion recorded on December 30, 2022, according to data from the Federal Reserve Bank of New York.
Fed Policy Shift Drives Decline in RRP Usage
The decline follows the Federal Reserve’s decision on Wednesday to lower the RRP rate by 5 basis points relative to the lower bound of the federal funds rate target range. This adjustment, coupled with the reduction in the overall target range to 4.25% – 4.50%, sets the new RRP rate at 4.25%, aligning it with the lower bound for the first time since 2021.
“This is the natural consequence of the Fed’s decision to realign the RRP rate with the lower bound of the fed funds target range,” explained John Canavan, an analyst at Oxford Economics. “Lowering the relative RRP rate makes it less attractive compared to other investment options, contributing to the broader trend of declining RRP demand.”
Implications for Liquidity and Quantitative Tightening
While the RRP balance, a key indicator of excess liquidity in the financial system, has decreased by roughly $2.4 trillion since its December 2022 peak, the pace of decline has moderated in recent months. Wall Street has long viewed the total cash held in the RRP as a crucial metric to monitor as the Fed continues its quantitative tightening (QT) efforts, unwinding its balance sheet.
The November meeting minutes foreshadowed this change, with policymakers indicating the potential benefit of a “technical adjustment” to equalize the RRP rate with the bottom of the federal funds rate target range.
Impact on Money Markets and Treasury Bills
Market analysts anticipated this move would exert downward pressure on money market rates and further influence the amount of funds deposited in the Fed facility. Since Wednesday’s adjustment, Treasury bills have offered higher yields than the RRP, potentially prompting the shift away from the central bank. However, this dynamic could change next week, as T-bill settlements are expected to reduce supply by approximately $70 billion, potentially lowering rates and driving funds back to the RRP.
“With the RRP now several basis points below bills in 1- to 3-month maturities, some investors likely moved into bills,” noted Steven Zeng, a strategist at Deutsche Bank.
The last time the Fed modified the RRP rate was in June 2021, when a surplus of dollars in short-term funding markets outweighed the supply of investable securities, depressing front-end rates despite the stability of the Fed’s benchmark. At that time, the overnight RRP facility held $521 billion.
Conclusion: A New Era for Short-Term Funding Markets
The recent decline in the Fed’s overnight RRP facility usage below the $100 billion mark signifies a notable shift in the financial landscape, driven by the central bank’s policy adjustments. As the Fed continues its quantitative tightening efforts and navigates the complexities of the current economic environment, monitoring the RRP balance will remain crucial for investors seeking insights into market liquidity and potential future rate movements. The interplay between the RRP rate, money market rates, and Treasury bill yields will continue to shape short-term funding markets in the coming months.
