Market liquidity alarm bells ringing! The usage of the Fed's reverse repurchase tool has dropped to below $300 billion, hitting a three-year low

Zhitong Finance APP noticed that the amount of funds held by investors in the Federal Reserve's main tools fell below $300 billion for the first time since 2021.

On Tuesday, 60 participants invested a total of $292 billion in the Federal Reserve's overnight reverse repurchase agreement (RRP) tool, marking a new low for more than three years since May 2021 for two consecutive days. Banks, government-supported enterprises, and money market mutual funds use this tool to earn interest. According to data from the New York Fed, this is a significant decrease from the record $25.54 trillion on December 30, 2022.

Market participants are closely monitoring the pace of consumption of this mechanism known as RRP. Some Wall Street insiders have warned that the depletion of this mechanism indicates that excess liquidity in the financial system has been drained, and bank reserve balances are not as ample as policymakers believe.

In June, the Federal Reserve began to gradually reduce its balance sheet at a slower pace, reducing the amount of Treasury securities it allows to be sold each month to alleviate potential pressure on money market rates.

Morgan Stanley strategist Teresa Ho and others stated last month that Federal Reserve officials may continue to reduce their balance sheet before the end of the year, predicting that the amount of RRP will be slightly below $300 billion, with reserves at $31 trillion.

From the government's suspension of the debt ceiling in June 2023 to April this year, the demand for Federal Reserve tools has decreased by about $1.8 trillion due to a large supply of bills. At that time, Wall Street strategists predicted that RRP would be completely depleted in the first half of 2024.

On the other hand, due to the decrease in the issuance of U.S. Treasury bonds and the uncertainty about the timing of interest rate cuts, cash has been stuck in RRP, keeping usage relatively stable. However, since the second half of July, the balance of the facility has been declining.

In early November last year, as the U.S. government issued a large amount of debt, money market funds gradually invested excess funds in U.S. government bonds, causing the usage of the Federal Reserve's RRP to fall below the $1 trillion mark for the first time since August 2021. Many market participants and central bank officials previously viewed the popularity of reverse repurchase tools as a sign of excess liquidity in the financial system, and vice versa.

Gennadiy Goldberg, head of U.S. interest rate strategy at TD Securities, said, "Over the past year, there have been significant changes in the trend of RRP, depending on the supply of U.S. Treasury bonds and the rate at which money market funds flow in. At the previous rate, RRP seemed to be rapidly approaching zero, but later we saw usage stabilize before gradually declining."