Fed’s liquidity tools see demand drop amid fresh repo market anxieties By Reuters

By Michael S. Derby

NEW YORK (Reuters) – Inflows into the Federal Reserve’s liquidity tools eased on the first day of the new quarter, although some in the markets now fear there are signs of increasing money market pressures that could prompt the central bank to rethink balance sheet reduction plans.

The Fed reported on Tuesday that inflows into its reverse repo facility fell to $375.2 billion from $465.6 billion on Monday, which was the highest since late June at the end of – the second trimester. Meanwhile, the Fed’s standing repo facility returned to zero after unexpectedly rising to $2.6 billion on Monday.

The increase and subsequent drawdown in the reverse repo facility was fully expected given the long-standing patterns of eligible firms – mainly money market funds – pouring cash into it on the last day of a given quarter. What was less expected on Monday was action from the Standing Repo Facility, or SRF.

The SRF was established in 2021 to allow eligible financial firms to surrender bonds to the central bank in exchange for quick cash. The facility was designed as a quick way to bring liquidity to the markets and as a safety valve in times of stress, preventing the Fed from intervening in the markets to keep rates in line with desired levels.

So far, the SRF has seen little more than testing. But Monday’s inflows were different and, while modest, represented the first real use of the facility, market participants said.

“This is a good news/bad news story,” analysts at Wrightson ICAP ( LON: ) told clients. The advantage is that the facility was eventually used, while the disadvantage is that it was used at a rate of 5% when the wider repo market rates were considerably higher, suggesting that the facility did not put a “effective ceiling” on rates, analysts said. .

Scott Skyrm, who heads money market trading firm Curvature Securities, noted that the rise in market rates that the SRF failed to moderate was “reminiscent of the volatile days of 2018 and 2019, culminating in the repo panic of September 2019.”

Skyrm added a reason why SRF may not have reduced the market rate increase due to time. Traders and investors settle their needs in the morning, while the daily operation of the SRF takes place in the early afternoon, after the market has already had problems.

Analysts at Barclays Capital said the rise in SRF reflects a market where demand for short-term collateralized funding is increasing amid a prospect of Fed interest rate cuts. And that could directly affect the Fed’s continued efforts to shrink the size of its balance sheet through what’s called quantitative tightening, or QT, a process in which the Fed allows bonds it owns to mature and not be replaced.

“Funding demand is above 2019 levels in a number of indicators, suggesting the Fed may need to end QT earlier, even if reserves are still plentiful,” Barclays said. As of July, the markets were eyeing a spring shutdown of QT.

In recent days, both Fed Chairman Jerome Powell and Roberto Perli, who heads the implementation of monetary policy at the New York Fed, have suggested that QT still has plenty of life amid still-abundant liquidity in the market.