Research Summary
The report discusses the Federal Reserve’s unwinding of measures that led to its largest monetary expansion on record, the subsequent shift in the repo market dynamics, and the implications of the RRP (reverse repo) balance reaching zero. It also highlights the role of banks, MMFs (money market funds), and the U.S. Treasury in this process.
Key Takeaways
Fed’s Unwinding of Monetary Expansion
- End of Excess Cash Era: The Federal Reserve has begun unwinding measures that led to its largest monetary expansion on record. This has resulted in the release of trillions of reserves from the Fed’s RRP facility to replenish the U.S. government’s bank account and fund quantitative tightening.
- Impact on Banks: Banks had absorbed so many low-yielding reserves that the Supplementary Leverage Ratio (SLR) began to threaten their bottom line. To make room for more profitable operations, banks initiated a “great shedding”, pushing deposits off their balance sheets and into the Fed’s RRP.
Role of U.S. Treasury and MMFs
- U.S. Treasury’s Role: The U.S. Treasury ended its issuance of Treasury bills used to fund emergency COVID operations in 2021, reducing the supply of safe assets significantly. However, in June 2023, it once again issued a deluge of Treasuries into the market, ending the safe asset deficit and initiating the RRP drain.
- MMFs’ Role: MMFs, which had developed a taste for short-term government debt, were forced to turn to the Fed’s RRPs as an alternative investment. They also received the banks’ deposit exodus, further increasing their need to invest in RRPs.
Implications of RRP Balance Reaching Zero
- RRP Drain: As the RRP balance reached zero, the dynamics in the repo market transformed. Cash available for repos will grow scarce, awakening once undead parts of the market and altering the status quo in the most crucial funding market globally.
- Repo Market Transformation: The return to an “excess collateral” era is expected as the RRP balance reaches zero. This will activate the upper levels of the Fed’s “repo hierarchy”, leading to significant changes in the global funding market.
Actionable Insights
- Monitor the Repo Market: As the RRP balance reaches zero, the dynamics in the repo market are set to transform. Stakeholders should closely monitor these changes and their potential impact on the global funding market.
- Understand the Role of Key Players: The roles of the Federal Reserve, banks, MMFs, and the U.S. Treasury in this process are crucial. Understanding their actions and strategies can provide valuable insights into the future direction of the market.
- Assess the Impact of Monetary Policies: The unwinding of the Fed’s monetary expansion measures has significant implications for the economy. Stakeholders should assess the impact of these policies on their operations and make necessary adjustments.
