Is liquidity flashing red again? The Fed's overnight reverse repo usage falls below $250 billion for the first time in three years

Signs of Excess Liquidity in the US Financial System - Usage of the Federal Reserve's Overnight Reverse Repurchase Agreement (RRP) Tool Hits a New Low.

Data from the New York Fed shows that on Monday, September 16th, a total of 44 counterparties, including banks, money market mutual funds, and government-sponsored enterprises, deposited a total of $239.4 billion into the Fed's RRP tool. This marks the first time since 2021 that the daily usage of RRP has fallen below $250 billion. The number of counterparties using RRP hit a new low since June 2021.

As of this Monday, the usage of RRP has shrunk by nearly 91% from the record high of $2.554 trillion set on December 30, 2022, and decreased by almost 64% from the high point less than three months ago. At the end of the second quarter on June 28th this year, RRP usage had risen to $664.6 billion, reaching a new high since January 10th, and since then, the funds deposited in RRP by institutions such as money market funds have been gradually declining.

Wall Street CN previously mentioned that the sharp drop in the scale of RRP usage indicates a warning sign for market liquidity, with increasing risks of a liquidity crisis. Some Wall Street insiders have warned that the depletion of the policy tool RRP indicates that excess liquidity in the financial system has been drained, and bank reserve balances are not as ample as policymakers believe.

From the suspension of the US government's debt ceiling restrictions in June last year to April this year, due to the sharp increase in US Treasury supply, market demand for RRP has decreased by about $1.8 trillion. In April, Wall Street strategists predicted that RRP would be fully depleted in the first half of this year. However, with the decrease in US Treasury issuance and uncertainties surrounding the timing of Fed rate cuts, RRP usage has begun to stabilize.

Market expectations for the start of a Fed easing cycle have been increasing recently, despite a recent reduction in US Treasury supply, funds within RRP have started to trend downwards again. Analysts believe this is due to money market funds seeking higher rates and an increase in other assets they can invest in.

Barclays reiterated earlier this month that they expect RRP balances to fall below $150 billion by the end of this year, and they still anticipate the Fed's balance sheet reduction (QT), or so-called quantitative tightening, to end in December this year