The Beginning Of The End

Relevant Comment by u/jsmar18

Let’s put some context to this which will help us understand from a macro Fed perspective why we’re seeing such a large increase in reverse repos (RRP).

RRP History

Back in 2013 is when the Fed launched its reverse repo program, they did this to suck out the extra cash in the repo market. (Repo = put money in, Reverse Repo = take money out from a macro perspective for the Fed)

Why?

Its operation help supports interest rate control by creating a “subfloor” on the wholesale short-term interest rates (refer to further reading below re the floor-subfloor system the Fed uses).

Rates, rates, rates

Four rates you need to know:

Federal Funds Rate: Interest rate banks charge when they lend to each other overnight

Federal Discount Rate: The interest rate on loans extended by the central bank to commercial banks, among others.

IOER: Rate of interest banks are paid by the fed on excess reserves.

RRP: As discussed above.

So this is how the floor subfloor system works, RRP Rate is set below IOER, and for the fed funds rates have a target range. IOER is the top of that range, the floor. and the RRP is the subfloor, the lower of that range.

Anyways..

Back to RRPs, the Fed is essentially sucking up excess liquidity through RRP (speculate as you wish on the other side of that transaction). They are doing this because they went Brrrrrr thanks to the Pandemic last year and their position of “No Negative Rates”. So yeah, all this to create a floor under the key market rates and to avoid negative rates through sucking liquidity out.

Why RRPs been increasing tho?

Reporting dates. Refer to this chart. Don’t you love how it spikes on the 31st of March (and every other EOM reporting month)? This is due to the fact financial institutions want to have their balance sheets look nice and shiny as funds from the fed look riskier.

As for non-reporting dates, a combination of dem attractive high-quality collateral, the increased RRP ceiling of from $40b to $80b, in late April reducing eligibility from $5b net assets to $2b and some other eligibility re government-sponsored enterprises. Again, all to avoid negative rates, it’s speculated that there’ll likely be an increase to rates in the future.

Develop those Wrinkles! Further Reading

Google around in regards to the floor system with a subfloor that the Fed uses, it’ll help you get a better understanding of how the IOER, Discount Rate, and ON-RRP rate works.

Also, google around for the impact of negative rates. A generalized stance is it makes life harder for the Fed.

Correct me if I’m there is anything wrong above, I was trying my best to consolidate a lot of info into a medium-sized comment. Edit: a word