It’s been awhile since I’ve written another post. I’ve decided to try and encompass all that I’ve learned from responding to many repo/money markets/ Fed RRP posts over the last few months. Since the focus always seems to be the Fed’s RRP operation, I’ll focus there. But before I do, I’d like to clarify one thing at the outset.
Repo and reverse repo are types of trades that are very common in Fixed Income. They are also two sides of the same trade. One side writes a repo and the other side writes the reverse repo. This can cause some confusion with how the Fed’s RRP operation is commonly referred to as the RRP but you’ll also find that there are probably 6 trillion in value of repo/reverse repo trades printed daily. I try to always refer to the RRP as “The Fed’s RRP” or “The Fed’s operation” to make it more clear.
What is the Fed’s RRP operation?
It’s a simple operation where participants provide cash and the Fed provides collateral at a fee of .0005 or .05% interest rate. This is done in triparty format, which means a third party, Bank of New York (Bony) , holds both the cash and the collateral in segregated accounts in the Fed’s and the participants name. A segregated account is one that Bony has access to, but only as a conservator. They can’t do anything with the cash or the collateral outside of the scope of the actual operation. They can’t send the collateral elsewhere, for they don’t have the authority and the same goes for the cash. Think of it like an escrow account you use when buying a home. It’s there, but the other side can’t take off with the money. Source – www.newyorkfed.org/markets/rrp_faq important details –
This dispels a ton of misconceptions about the operation about how the collateral can be used. Many have thought the collateral could be used for posting margin for institutions that need it for margin call. This is just completely false. It just sits in the accounts and the next business day, returned to the rightful party.
Who is using the Fed’s RRP?
The details about who is borrowing is private, as far as the Fed is concerned. However, they provide details as far as what type of institutions are borrowing, broken down into 4 categories, Primary Dealers, Banks, GSEs, and Money Market Funds. This data is released with a 6 month delay, meaning the data from April to July was just released in October. The details from July until October will be released at the beginning of January. You can go to this site www.newyorkfed.org/markets/desk-operations/reverse-repo and look up any date from 2013 up until 7/1/2021. The largest print available that we can look up is the 992bln print on 6/30th. The breakdown for that date was
86% Money Market Funds
1.5% primary dealers
Another common misconception is that “banks” are using the RRP for whatever reason. As you can see above for 6/30th, that simply isn’t the case. When I summed up all the details from 4/2013 to 4/2021, the results were mostly the same. GSEs weren’t involved but MMFs were the major player and “banks” were but 1%. This doesn’t fit with many narratives that people want, but facts are facts.
Why are MMFs using the RRP?
This is quite simple, but again, the facts don’t fit the narratives people want. The RRP operation took off in March, when the award rate was .00%. Seems to be a pretty silly investment to “invest” at zero, but it’s actually the least silly option. If you go to this link www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=billRatesYear&year=2021 And scroll down until you see the yields on the 1, 2 and 3 month bills at .01. Now yields in the bond market are based on the bid side, so if the bid is .01, the offer will be .00 (technically, the offer would be .005 but the brokerage fee would be .005 so the result is .00). Now, why are we looking at 1-3 month yields? Because that’s where MMFs invest. They have a 60 day WAM (weighted asset maturity) which means their entire portfolio must, on average, mature within 60 days. Thus, they live in the 1-3 month area with their investments. As seen from the link above, in mid March, all those yields would have been .00 to purchase. If you were a MMF, would you choose to
Buy 3 month bills at .00 and lock in that rate for 90 days?
Buy 2 month bills and lock in .00 for 60 days?
Buy 1 month bills and lock in .00 for 30 days?
D. Use the RRP operation at .00 for 1 business day and hope that tomorrow brings a higher rate?
It becomes pretty simple and logical when viewed this way, but again, doesn’t fit with certain narratives.
You can use that above link and see the day that the Fed changed the award rate to .05%, because the bill yields for 1-3 months changed that same day. They had to move up, because no one would buy a bill yielding lower than the award rate, at least no one with access to the Fed’s RRP operation.
That little fact about the award rate moving the bills higher dispels another common mistake about a “bill shortage”. Bills are expensive, but if the bid was .01 in March but .05 in June, how can there be a shortage yet they are now cheaper? It can’t, they are still expensive but if you want to buy them at .03 or lower, people will sell them to you.
How long can this last?/Is this sustainable?
The Fed uses the SOMA portfolio for these transactions, it has over 5 trillion of treasuries that can be used for this operation. www.newyorkfed.org/markets/soma-holdings That’s about as much as the entire MMF world has in cash, let alone just the ones approved for the operation. You can see that amount here www.financialresearch.gov/money-market-funds/
Bottom line, the Fed can handle more than the operation could ever be used.
Why is it being used so much now, when historically, it hasn’t been?
A couple reasons. First, in 2011, the Fed overhauled the operation, it used to only include Primary Dealers, who by nature, aren’t cash rich, they are securities rich. It doesn’t fit into their model to use. So in 2011, the Fed included MMFs, GSEs, and Banks. This was made aware to them in 12/2008 when rates were dropped to 0% and we had pressure to move into negative rates. Thus the overhaul.
Secondly, the “Why Now?” answer has to do with the amount of money that has flooded the system in since the pandemic. Globally, 20 trillion worth of stimulus packages have been granted. In addition to that, the Fed has been performing QE injecting 120bln a month. Most markets have been hitting all time highs, be it stocks, commodities, real estate, used cars, even used cell phones. You can see in the last link I posted that 1 trillion hit the MMF world in March of 2020. It took a year to drive short rates to zero but when they got there, the RRP launched off.
When will it stop?
I can’t say for certain, I’m not sure anyone can. But my guess will be after QE stops and stimulus packages also stop. When the cash stops coming in, rates in the front end will back up. As soon as yields in short bills get 4-5 basis points (.0004-5) above the award rate, MMFs will purchase those instead of the RRP for it makes more sense. But the actual “when” is up to both politicians and the Fed.
Does the RRP use portend/signal some impending collapse/crisis?
No, that would be the RP now known as the SRF (standing repo facility). The RRP operation is like seeing someone on crutches. You know something bad happened, but they’ve seen someone to get aid and are on the road to recovery. They are still hurt, but the “bad thing” already happened. The RRP gets used so much when rates are dropped to zero. If rates have been dropped that low, something bad happened (Global pandemic) which has caused short rates to drop and cause the RRP to be engaged.
(To finish what I mentioned above, the SRF being used would be a signal that there is a liquidity issue in the funding market and dealers as well as anyone levered in fixed income will be experiencing some issues. I down play the RRP operation because it’s quite benign, but the RP/SRF is a big warning of market issues)
I think that should cover the bulk of questions and misconceptions of the RRP operation. Hope you find this helpful and if you have further questions, just ask.