Growing Calls for Fed to Slow Pace... Reverse Repo Balance Falls Below $500 Billion

The balance of reverse repurchase agreements (reverse repos) managed by the U.S. Federal Reserve (Fed) has fallen below $500 billion, the Wall Street Journal (WSJ) reported on the 26th (local time). This figure is only about 20% of the $2.5 trillion level seen in early last year when the Fed aggressively raised interest rates. The speed of fund outflow is steep, with the reverse repo balance halving in about three months since it dropped below $1 trillion in November last year, after more than two years.

Reverse repos refer to the New York Federal Reserve Bank (NY Fed), which is responsible for the Fed's open market operations, borrowing money from U.S. money market funds (MMFs) and others using government bonds as collateral. Conducting reverse repos has the effect of withdrawing liquidity from the market.

MMFs, which invest in safe assets while seeking short-term yields, poured large sums into reverse repos during the rate hike period. This is because they provide risk-free daily returns equivalent to the annual interest rate close to the benchmark rate. Last year, MMFs surpassed $6 trillion in total assets for the first time ever, with a significant portion of funds invested in reverse repos.

However, demand for reverse repos began to sharply decline from the second half of last year. First, investment options offering better yields have expanded. Additionally, the supply of government bonds has increased. The size of short-term government bonds (T-Bills) maturing within one year, which was only $2 trillion in 2017, has recently surged to $6 trillion.

The outlook is that reverse repo funds will continue to decrease. Blake Gwinn, head of U.S. interest rate strategy at RBC Capital Markets, predicted, "At this rate, about $100 billion to $200 billion will remain in reverse repos."

The near exhaustion of reverse repo funds can also be interpreted as a red light for the Fed’s tightening funds. As the pace of reverse repo fund reduction accelerates, WSJ forecasted that the Fed will slow the pace of quantitative tightening that reduces the size of its balance sheet. This is because the Fed is expected to examine potential risks arising from the decline in reverse repos.