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March Drama is getting closer! The balance of reverse repurchase by the Federal Reserve has fallen below the $500 billion mark

Release Time:2024-02-18

The balance of the Federal Reserve's reverse repo has fallen below the $500 billion mark for the first time in over two years, and market liquidity has once again lit up a red light. The risk of a liquidity crisis erupting in March is increasing.

The latest data released by the Federal Reserve shows that on February 15th local time, the balance of overnight reverse repurchase (RRP) by the Federal Reserve decreased by $82 billion to $493 billion from the previous day, marking the first time since June 2021 that it has fallen below $500 billion.

This is also the largest non month end decline since October last year, which is quite shocking because the use of reverse repo has been relatively stable recently.

As Curvature analyst Scott ED Skyrm pointed out:

Considering the loose financial situation, this is even more surprising.

When the repurchase rate is at a low level, the usage of reverse repurchase often decreases less, as a 5.3% reverse repurchase rate is more competitive compared to market rates.

Wall Street has previously mentioned in an article that reverse repurchase may be completely depleted by March this year. At the same time, some people expect the reverse repurchase balance to remain at a "sustained low level" of $200-300 billion.

Is there a big play in March?

It is worth noting that the depletion of reverse repurchase may only be one part of the "March drama" play.

The repurchase rate has jumped several times since the fourth quarter of last year, releasing a price signal of liquidity pressure.

In addition, the Bank Term Financing Program (BTFP), an emergency rescue tool launched by the Federal Reserve during last year's banking crisis, will expire in March and will no longer be renewed, forcing banks to fund their $160 billion shortfall through a discount window.

This suggests that liquidity risk may erupt in March.

At that time, the Federal Reserve will be forced to stand at a crossroads again. What choices will it make in response to the crisis?

Is it a rate cut? End QT? Even enable QE?

Dallas Fed Chairman Logan pointed out as early as January that as reverse repurchase balances approached lower levels, the Fed should slow down the pace of QT.

In the same month, Bill Gross, known as the "old debt king," said that if he were the Chairman of the Federal Reserve, he would stop QT now and start cutting interest rates in the coming months to avoid an economic recession.

Some Wall Street strategists have previously hinted that the Federal Reserve should completely stop QT before the reverse repo balance approaches zero.

Some analysts also believe that it was too late for the Federal Reserve to stop quantitative tightening at that time, and it was impossible to avoid violent fluctuations in the treasury bond bond market. Hedge funds would become the "fuse" to rapidly reduce market liquidity. The Federal Reserve would end QT and restart QE in the next few months even at the risk of inflation resurgence.

However, QE may not be a benchmark option.

Although liquidity risk is gathering, it is currently difficult to determine whether and when it will erupt.

Despite the depletion of RRP and the expiration of BTFP, the Federal Reserve still has two policy tools, the Domestic Standing Repurchase Facility (SRF) and the International Repurchase Facility (FIMA), to improve the "interest rate corridor" mechanism and prevent overnight interest rates from frequently breaking the interest rate ceiling during the process of tightening liquidity.

In addition, Federal Reserve officials have publicly encouraged lending institutions to freely use the central bank's discount window for financing, and hope to use this financing tool as an important tool for maintaining financial stability and monetary policy.

Therefore, the volatility of repurchase rates and the significance of BTFP should not be overly exaggerated.
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