Fed Liquidity Tools Experience Reduced Demand Amid New Repo Market Concerns, Reports Reuters

By Michael S. Derby

NEW YORK – On the first day of the new quarter, inflows into the Federal Reserve’s liquidity tools diminished, leading to concerns in the markets about potential pressures in money markets that could prompt the central bank to reconsider its plans for reducing its balance sheet.

According to the Fed, inflows into its reverse repo facility dropped to $375.2 billion from $465.6 billion, which had been the highest level since the end of June, marking the close of the previous quarter. In contrast, the Fed’s Standing Repo Facility returned to zero after an unexpected rise to $2.6 billion on the preceding day.

The increase and subsequent decline in the reverse repo facility were anticipated, given the historical trend of eligible firms—primarily money market funds—investing cash into it on the last day of each quarter. However, the movement in the Standing Repo Facility (SRF) on Monday was less expected.

Launched in 2021, the SRF allows eligible financial institutions to exchange bonds for immediate cash from the central bank. It was designed as a quick liquidity source for markets and a safeguard during stressful times, helping the Fed avoid direct market interventions to maintain desired interest rates.

Until recently, the SRF has only seen limited testing, but Monday’s inflows indicated its more substantial usage for the first time, according to market participants.

"This is very much a good-news/bad-news story," analysts from Wrightson ICAP reported to their clients. The positive aspect is that the facility was utilized, while the downside is that it was accessed at a 5% interest rate when broader repo market rates were considerably higher, indicating that the facility wasn’t effective in capping rates.

Scott Skyrm of Curvature Securities remarked that the market rates the SRF was unable to contain were reminiscent of the volatile periods of 2018 and 2019, which climaxed with the repo market crisis in September 2019.

Skyrm suggested that timing might have played a role in the SRF’s ineffectiveness, noting that traders generally assess their needs in the morning while the daily SRF operation occurs in the early afternoon, after the market has already faced challenges.

Analysts at Barclays Capital emphasized that the rise in SRF usage reflects increasing demand for short-term secured financing amid expectations of Federal Reserve rate cuts, which could directly impact the Fed’s ongoing efforts to reduce its balance sheet through a process known as quantitative tightening (QT). This process allows bonds owned by the Fed to mature without replacement.

Barclays pointed out that "funding demand exceeds 2019 levels across a number of metrics," indicating that the Fed might need to halt QT sooner, despite still having ample reserves. As of July, there were discussions about a potential end to QT in the spring.

In recent statements, both Fed Chairman Jerome Powell and Roberto Perli, who oversees monetary policy implementation at the New York Fed, have indicated that QT still has considerable momentum, even with ample market liquidity.