MNI INTERVIEW: Reverse Repo Facility Decline To Slow- KC Fed

Falling usage of Federal Reserve’s overnight reverse repurchase facility will soon slow and substantial further reductions will likely need to come from other sources that could prove more difficult, Kansas City Fed researcher Stefan Jacewitz told MNI.

That could have implications for QT as so far the sharp decline in ON RRP take-up is offsetting both the increase in the Treasury General Account and the reduction in the Fed’s balance sheet, avoiding any contraction in bank reserves. Reserve balances have been trending up over the year, reaching nearly USD3.5 trillion this week, suggesting the Fed's efforts to shrink its balance sheet has plenty of space to run.

The value of assets held at the Fed's ON RRP facility has plunged 60% since June, declining over USD1.2 trillion to USD912 billion. But "the rapid decline we've experienced recently is probably going to slow down" as the Treasury nears its projected cash balance target, Jacewitz said in an interview.

"That particular avenue for ON RRP reduction is probably closed for now, or at least smaller," Jacewitz said. "What that means to me is if we're going to see further large reductions in ON RRP that we've seen recently, we're probably going to have to look somewhere else for it."

Treasury had ramped up issuances after its operating account at the Fed had been nearly depleted during the debt ceiling standoff in Congress, which ended in early June.

The decline in ON RRP take-up -- even as assets under money market fund management rose USD260 billion -- has been facilitated by a USD1.6 trillion increase in T-bills outstanding. Treasury this month suggested it would continue to lean more heavily on T-bill issuance rather than longer term debt, but that won't be enough to keep draining ON RRP at the current rate, Jacewitz said.

NOT GOING TO ZERO

Bank-sponsored money market funds may be reluctant to exit ON RRP for other reasons. With the supplementary leverage ratio still binding and the banking industry flush with cash, demand for short-term funding from the repo market may be limited, Jacewitz said.

"Further reductions will have to come from either money market funds rotating into short term Treasuries or lending money into the private sector," the KC Fed researcher said. "That is one thing that hasn't been discussed enough."

Reductions in ON RRP could occur if the Treasury repo market shifts away from the Fed as a counterparty and back to private counterparties. "This reduction would have to be fueled by private counterparties not only moving back into the market, but they need to demand more than they have historically. That shift away from the Fed and back to private participants is underway," he said.

Still, Jacewitz said he is not expecting the value of assets held at the Fed's ON RRP facility to reach zero anytime soon. (See: MNI: Forks In Road Ahead For Fed's QT Plan -Ex-Staff)

"If it were to keep shrinking at this recent pace, if we were just to draw up that trend line, which I don't think would happen, then it can reach zero in 2024," Jacewitz said. "In my opinion, a significant balance in ON RRP is probably more likely than something closer to zero at least for next year." Even when QT ends, some usage of the ON RRP could be "around for some time," he said.