The Rise and Fall of RRP ( MMFs, SLR and T-Bills)
A reverse repurchase agreement or reverse repo history in the last 2 decades. What is a reverse repurchase agreement ? How does Fed use a reverse repurchase agreement in monetary policy?
What is a Reverse Repurchase Agreement ?
A “reverse repo” or “RRP” is a transaction in which the Fed sells a security to an eligible counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future.
*Eligible counterparties: Primary dealers and RRP counterparties, which include 2a-7 money market funds, banks, and government-sponsored enterprises.
Reverse Repurchase Transactions1 and its volume data2 and its rate data3 and its faq.4
What is the RRP’s Effect on Fed’s Balance Sheet ?
Here's a simpler explanation of the Federal Reserve's Reverse Repo (RRP) open market operations:
Selling Securities: During RRP operations, the Fed sells some of its U.S. Treasuries to the buyers are known as eligible RRP counterparties.
Temporary Sale with a Promise to Buy Back: This sale is not permanent. The Fed agrees to buy these securities back after a certain period.
No Change in Overall Portfolio Size: Even though the Fed sells these securities, its overall collection of assets in the SOMA doesn't really decrease in size. This is because, according to the rules of accounting, these sold securities are still considered part of the Fed's assets. They're just temporarily in someone else's hands.
Shifting Liabilities on the Balance Sheet: When it does these RRP operations, it changes the outlook of liabilities on its balance sheet. Money that was previously recorded as bank reserves is now recorded as reverse repo.
In summary, when the Fed does these RRP operations, it's like it's lending out its securities for a short time and agreeing to buy them back later. This process doesn't really shrink its overall assets, but it does change the outlook of its liability side.
RRP is complement IOER by helping to set a floor on short-term rates
We now focus on the historical RRP data published by FRED. You can see that before 2013, the Fed used the RRP tool at a low level to sterilize liquidity in the repo market. This volume increased in both 2014 and 2021, each time for different reasons.
In 2014, the tool's aim has directly changed; the RRP is used as a subfloor below the IORB(IOER) rate. This new job led to the first significant increase in RRP volume on the Fed's balance sheet.
It realized its mission as a subfloor below the IORB(IOER) rate. This text explains the RRP new mission in the Fed’s monetary policy.
This is an interesting note: 'While IOER was available only to depository institutions, overnight RRPs could be made available to non-bank investors that are active in the money markets.”
MMFs love the RRP
As of March 2021, the exemptions on SLR for banks were removed. SLR, in the simplest terms, is a set of measures that require banks to hold capital against their assets. After March, banks began temporarily removing these reserves from their balance sheets. This money was transferred to MMFs. MMFs then utilized these deposits in reverse repos.
The Fed’s RRP was the highest-yielding vehicle for many MMFs, which is why the RRP balance had been gradually increasing in 2021. The RRP increased from close to zero in early 2021 to $2.2 trillion in December 2022. In addition to this, the decrease in the T-bill supply in 2021-22 (price goes up and interest goes down), resulting from the normalization of public debt after the COVID-19 crisis, increased the demand for MMF's RRP.
RRP : Like a Rolling Stone
During the first half of 2023, which was a period of relatively stable balances, the Overnight Reverse Repo Facility (ON RRP) has halved over the past six months, declining by more than $2 trillion since June 2023.
The Federal Government has expanded the supply of T-bills dramatically in 2023: T-bills outstanding increased from $3.7 trillion at the end of 2022 to $5.3 trillion at the end of September 2023. T-bill supply has grown significantly (price goes down and interest goes up), this growth offers MMFs more investment avenues, potentially making ON RRP less attractive or necessary.
Treasury-backed repos have increased since 2023 and are now a few basis points above the ON RRP rate, as shown in the chart below. This positive rate differential pushes MMFs away from investing in the ON RRP facility and toward private repos.
EXTRA NOTE: The Federal Reserve is reducing the bonds on its balance sheet by not reinvesting in maturing bonds. Normally, the following mechanism works in the Fed’s balance sheet.
While the bonds decrease, the reserve money remains unchanged. How could it be? In return, the Federal Reserve's reverse repo liabilities to funds are decreasing and reverse repo liabilities converts to reserves liabilities. The Treasury is borrowing from these reserves and paying its debt to the Fed.
References
“Banks’ Balance-Sheet Costs, Monetary Policy, and the ON RRP.” Federal Reserve Bank of New York, Staff Report no. 1041, December.
Dropping Like a Stone: ON RRP Take‑up in the Second Half of 2023
Gara Afonso, Marco Cipriani, and Gabriele La Spada, Link
“The Fed’s Footprint in U.S. Money Market Funds Has Grown Significantly since 2021.” Federal Reserve Bank of Kansas City, Charting the Economy, June 20.
“Shadow Insurance? Money Market Fund Investors and Bank Sponsorship.” Review of Corporate Finance Studies, vol. 11, no. 2, pp. 414–456.
“The Borrower of Last Resort: What Explains the Rise of ON RRP Facility Usage?” Federal Reserve Bank of Richmond, Economic Brief no. 21-43, December..
Overnight RRP Operations as a Monetary Policy Tool: Some Design Considerations, Link
American SICO - 4.1 A Band-Aid Known as Reverse Repo, Link
Wonderful post as always