In order to maintain the federal funds rate within its band (0 – 25 basis points), the New York Federal Reserve conducts various operations, including reverse repurchases. Much is being made of the increase of this facility as it moved from near nothing in the first quarter to as much as $992 billion at the end of the second quarter, and currently sits at close to $800 billion.
In normal times, the Treasury issues T-bills along with its regular bond auctions to both roll over maturities and cover the deficit. However, the Treasury in advance of the July 31 debt ceiling deadline is letting its cash balance decrease ($886 billion YTD through July 9), which has resulted in negative bill issuance (net Sifma T-bills of -689.1 billion YTD through June). This leaves short-end buyers without assets as their T-bills mature and there are inadequate replacements. By extension, it has led these buyers to press front-end rates lower, producing declines in the fed funds to as low as 5 bps and in the three-month T-bill to 0.003% in May. This is why the Fed hiked interest on excess reserves to 15 bps from 10 bps and started paying 5 bps on the reverse repurchase facility in June—helping to move fed funds back to 10 bps, more in the center of its rate band.
To the extent that the 5 bps on the reverse repurchase facility is close to or greater than the yield offered on T-bills, that incentivizes both holders of bills (money market funds) and deposit holders at banks to move into the Fed facility. Some of that move of bank deposits is potentially welcome due to supplementary leverage ratios, but not all. Liquidity is plenty until it isn’t. There are potential stability issues if money automatically flows to the Fed instead of the private sector in times of turbulence.
As large as these amounts seem—and make for exciting tweets—at this point, we don’t see much to be concerned about. This number will continue to increase as the Treasury reduces its general account and the Fed continues with QE. What will be interesting, once bill issuance returns, is how the market reacts to that supply and what it means for overall interest rates and credit as those short-term rates return to “normal” levels of 10 – 15 bps. But that is likely a 4Q discussion and one there should be plenty of time to prepare for.