Bank reserves are on track to approach a common estimate of the Lowest Comfortable Level of Reserves (“LCLoR”) within a few months. At the moment, reserves sit around $3.2t and a common Fed estimate places LCLoR at around $2.2t (8% of GDP). In addition to quantitative tightening, two events may soon reduce bank reserves to around $2.2t. First, the RRP is likely to steadily increase as MMF assets continue to rise and FHLB debt issuance declines. Second, the Treasury General …
Tag: ON RRP
A change in the underlying plumbing of the financial system is making it unlikely that QT can run its expected 2+ year course. An ideal QT would drain liquidity in the overall financial system while keeping liquidity in the banking sector above a minimum threshold. That is only possible if the bulk of the liquidity drained is sourced from the $2t RRP, which holds funds owned by money market funds. MMFs could facilitate QT by withdrawing funds from the RRP …
A rapid decline in the level of bank reserves would be an obstacle to QT that may prompt action from the authorities. An aggressive QT was premised on first draining the large RRP balances, but the monetary plumbing suggested that was never likely. Banks can easily maintain their own reserve levels, but their own target levels are significantly below those of the Fed. This implies that bank reserve levels will likely fall below the Fed’s comfort level far before QT …
The money supply is set to contract just as investors are clamoring for cash to hide from declines in both equities and bonds. A combination of increasing MMF allocation to the RRP and QT may drain ~$1t of bank deposits by the end of the year. The Treasury’s decision to further cut bill issuance will keep money market rates very low and likely push the RRP to over $2.5t by the end of the year. Furthermore, recent history suggests QT …
The $1.7t in the RRP can help finance the upcoming deluge of coupon Treasuries, but it won’t be easy. Treasury bills will easily be funded, but the bulk of the upcoming supply from net issuance and QT is likely coupons. There are only two ways the RRP can finance coupon Treasuries: 1) funding repo loans to leveraged Treasury investors or 2) funding money fund redemptions to cash Treasury investors. Both mechanisms are subject to frictions that suggest a messy process. …
Large money market investors will move billions for even a basis point. A 5bps increase to the RRP offering rate led to a $200b+ surge in participation, but there is a wrinkle to the story. The bulk of the increase likely came from Government Sponsored Enterprises (“GSEs”) who were leaving hundreds of billions at 0% in their Fed account, so it was not an incremental flow from the private sector. That being said, the 5bps increase puts money market funds …
The humble ON RRP is in the spotlight as take-up marches steadily upwards. It will go much, much higher. Increasing participation is largely a function of two structural forces in the financial system: on-going Fed QE ($120b/month) and Basel III constraints. On the margins, changes in the level of the TGA have some impact as well. Water pouring into a glass remains in the glass, until the glass is full and then every incremental drop overflows. The Fed has been …
The Fed would like the ON RRP to play a bigger role in its rate control framework, but the ON RRP has been and will always be a very leaky floor for money market rates. From 2016 to early 2018, Treasury bills and agency discount notes consistently traded several basis points below the ON RRP. Today, even tri-party GC repo is occasionally dipping below the floor. The floor will only get leakier as money floods into the front end: QE …