TL;DR Too much cash, not enough collateral.
Disclaimer: I am by no means an expert on this topic, I like to snort green crayons but recently have been getting into some reds, and therefore barely know wtf I’m talking about. I’m not arrogant enough to claim I know everything to do with this and won’t pretend to. Do your own DD, come up with your own conclusions, and remember the economy always goes up until it doesn’t.
Outside of a few select stock subreddits that I shall not name here, not many people seem to be talking about Reverse Repos and their subsequent effect on the market. Let’s fix that, shall we?
What are Overnight Reverse Repos (ONRRP)?
I’m not gonna bore the shit out of y’all with a bunch of technical jargon so I shall simplify it (and note: this is a simplification and therefore some nuance and detail is not included, so go f*ck yourself if you feel the need to be an ass about something I didn’t include.)
Reverse Repo’s are basically an agreement between the Federal Reserve (which is not the same thing as the Federal government) and large financial institutions (banks, hedge funds, Market Makers, your wife’s boyfriend, etc.) that basically boils down to the Fed giving these institutions a “specified security” (usually U.S. Treasury Bonds) in exchange for cash. Now, since the government is stingy with their T-Bonds and Financial institutions might need their money back at a moment’s notice, these transactions are essentially reversed at the end of the day.
The Reverse Repo Program (Or RRP for short) is “officially” used to tighten the money supply. (Note how I said officially, I’ll come back to that later.)
Now, there is another program that is sometimes mentioned, called the Repo Program, which is basically the opposite of the Reverse Repo. It is used to “inflate” the money supply in the economy. I will not go into much more detail on this program since I have used my remaining few brain cells to understand Reverse Repos and not much else.
Cool, but, like, why?
So to understand why this program is essential to “control the money supply” (aka Decrease Inflation), you have to understand one thing about these big financial institutions.
Cash = Bad
Seems counterintuitive, right? Well, sort of. Basically, cash in itself is bad for these businesses because of one simple reason; Inflation. Cash is considered a liability (a risk) on their balance sheets when it’s just sitting there not doing anything. Does the phrase “Use money to make money” ring a bell? Regardless, Institutions need to have most of their money in investments in order to not lose money and any opportunities to make money.
Now that we’ve gotten that out of the way, let’s talk about what exactly these bad boys have been doing for the last year and a half.
What the Fed doin’?
Here I’m going to lay out the facts of the matter and leave the speculation as to the why’s further down in the next section. So, I hope y’all like pictures.
Starting in March of this year, The RRP had begun to be used after nearly a year of nothing. This began after margin requirements for banks were reinstated in March after the Fed had significantly lowered them to help the economy after the COVID crash.
It has only increased since.
Not only that, the way it has increased is rather unusual compared to the past. Up until around late 2018, the RRP market was used rather frequently but usually only during Quater ends.
So this sharp increase with seemingly no correlation with Quarter ends has led to a lot of people smelling the bullshit so to speak.
1 Trilly Baby
Since August 11th, the RRP has been above 1 Trillion and has, as of August 31st, hit a high of 1.189 Trillion. The previous high before this year was around $474 billion in 2015, right at the end of Quater 4.
Why is this happening?
The simple answer is that we don’t know. Don’t pull out the pitchforks quite yet, there are a few theories as to why just no concrete reason (as of yet) since none of the big boys want to reveal their hands.
Stock Market Crash
The Stock Market has been reaching ATH’s for the last few weeks and with the eviction moratorium ending, and possibly up to 11 million families at risk of losing their homes, there’s a chance a crash is coming which may make 2008 look like peanuts in comparison. (MBS’s anyone?) “The last time this many families were behind on their mortgages was during the Great Recession.” – CFPB
In regards to this coming crash, it’s possible that big investors are unwilling to risk putting more money into the market when they can rely on the government with their T-bonds. (Which also helps their margin requirements, so win-win for them.) I admit, this is pretty speculative and needs further research than what I’m willing to do right now.
There is some evidence that there is an actual shortage of Treasury bills within the market (dropping yields from their highs earlier this year) which could explain the Big Boys reliance on the FED and RRP. Oh, and the money printer himself, JPOW, said this, “You could say there is a shortage of safe short assets… there’s a shortage of T-bills”. So, yeah that’s mildly concerning.
Another reason as to the apparent need for bonds could be risky bets made by financial institutions (“meme” stocks anyone?) and the inevitability of short positions bankrupting them. I seriously doubt any of the big boys have closed most of their short positions yet so this is my personal theory.
There is also a chance that it’s a combination of all three, none, or something else entirely that has yet to rear its ugly head.
TL;DR PT 2
The point is; Reverse Repo’s are a signal that the market is in risky shape due to unavoidable monetary policy decisions by the Fed (brought on by COVID) and Financial Institutions taking incredibly risky bets with other peoples’ money. Time will tell what exactly caused this spike in Reverse Repo’s but I’d hedge your bets whichever way you can.
References: Federal Reserve Bank of New York, Overnight Reverse Repurchase Agreements: Treasury Securities Sold by the Federal Reserve in the Temporary Open Market Operations [RRPONTSYD], retrieved from FRED, Federal Reserve Bank of St. Louis; fred.stlouisfed.org/series/RRPONTSYD, September 3, 2021.
Lewis Huxley. (2021, August 6). Reverse repo and the Collateral Crisis. The London Financial. www.thelondonfinancial.com/markets/reverse-repo-and-the-collateral-crisis.
www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yieldYear&year=2021 (Bond Rates)
wolfstreet.com/2021/05/20/fed-drains-351-billion-in-liquidity-from-market-via-reverse-repos-as-banking-system-creaks-under-mountain-of-reserves/ (Additional RRP source.)
fred.stlouisfed.org/series/RPONTSYD (Repos Over Time)
fred.stlouisfed.org/series/RRPONTSYD (RRP’s Over Time)
www.consumerfinance.gov/about-us/newsroom/new-report-from-consumer-financial-protection-bureau-finds-over-11-million-families-at-risk-of-losing-housing/ (11 Million Families Losing Homes)