via dismal-jellyfish:
Source: libertystreeteconomics.newyorkfed.org/2023/12/dropping-like-a-stone-on-rrp-take-up-in-the-second-half-of-2023/
Background: Liberty Street has a paper Treasury Bill Supply and ON RRP Investment based on the Staff Report Banks’ Balance-Sheet Costs, Monetary Policy, and the ON RRP.
TLDRS:
- The authors call out the increase in Overnight Reverse Repurchase (ON RRP) take-up from 2021 to May 2023 was influenced by several factors, including higher balance-sheet costs for banks due to the expansion of reserve supply following the pandemic.
- Other contributing factors were the rapid increases in policy rates to combat inflation, which led to greater interest-rate uncertainty, and a reduction in the supply of Treasury bills (T-bills) during 2021-22 as part of the normalization of public debt pandemic.
- Recent trends show a reversal of these factors: the Federal Reserve has begun reducing its balance sheet size, which had temporarily expanded during the banking turmoil of March 2023.
- The growth of the banking system has slowed, and the ratio of reserves to assets has decreased.
- The pace of interest-rate hikes has slowed down.
- There has been an increase in the T-bill supply again.
- If these trends continue, the take-up of ON RRP is likely to continue decreasing.
- This potential decline in ON RRP take-up could mirror the trend observed in early 2018 when investments in ON RRP gradually reduced as the Federal Reserve continued to normalize its balance sheet and reserves in the banking system became less abundant.
Additional information:
The reason ON RRP has been dropping recently is called out in the most recent FOMC minutes:
On the liabilities side of the balance sheet, usage of the overnight reverse repurchase agreement (ON RRP) facility declined further, as money market mutual funds continued to absorb new Treasury bill issuance and appeared to increase investment in the private market for repurchase agreements (repos) as well.
– October 31–November 1, 2023 FOMC Minutes
- Between January 2021 and June 2022, money market funds (MMFs) significantly increased their investments in the Federal Reserve’s Overnight Reverse Repurchase (ON RRP) facility by $2 trillion, while their lending in the private repo market decreased by almost $500 billion.
- MMFs, the largest providers of cash to the repo market and main investors in the ON RRP facility, continued lending in private repo markets at rates below the ON RRP rate.
- Despite their shift towards ON RRP, private repo borrowing remained steady as dealers sought liquidity from other sources, like affiliates, to compensate for reduced funding from MMFs.
- The ON RRP facility aims to set a floor on overnight lending rates for MMFs, affecting private repo market rates and quantities.
- MMFs have demonstrated flexibility in lending rates, occasionally accepting rates below the ON RRP rate for reasons like maintaining dealer relationships and managing late-day flows.
- MMFs’ private-repo counterparties, primarily dealers, responded to reduced funding from MMFs by increasing funding sourced from their affiliates.
This shift suggests a growing importance of affiliate relationships in maintaining liquidity amidst changes in MMF lending behavior. - The repo market, vital for short-term lending against collateral, has seen FICC’s sponsored GC service grow in volume, providing benefits like netting to dealers.
- MMFs are significant participants in this market, typically through tri-party repo or bilateral centrally cleared repo.
- The Federal Reserve’s ON RRP facility, heavily utilized by MMFs, helps support the Fed’s target range for the federal funds rate by setting a floor under overnight rates.
- However, the facility’s control over repo rates is not absolute, as evidenced by MMFs’ willingness to accept lower rates.
- The interactions between the ON RRP facility and the private repo market continues to play a significant role in setting overnight interest rates.
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