Explanation: How excess liquidity occurs in money markets and reverse repurchase agreements in the United States


An eagle looms over the facade of the US Federal Reserve building in Washington, July 31, 2013. REUTERS / Jonathan Ernst / File Photo

NEW YORK, July 2 (Reuters) – The US debt ceiling returns to effect at the end of July, putting pressure on the Treasury to reduce its cash flow ahead of the deadline. This means more injections of liquidity into a financial system that is already overflowing with liquidity, which could lower short-term rates and cause undue distortion of money markets.

Nearly a record trillion dollars in cash poured into the Federal Reserve’s reverse repurchase facility (RRP) on Wednesday.

On Thursday and Friday, reverse repo volumes reached $ 742.6 billion and $ 731.5 billion, respectively.

The record volume came after the Fed last month made a technical adjustment to the interest rates it manages, raising the rate paid by banks on excess reserves (IOER) held at the Fed to 0, 15% against 0.10% and increasing the rate paid on repurchase agreements to 0.15%. 0.05% from zero.


The Fed launched its reverse repo program (RRP) in 2013 to mop up additional liquidity in the repo market and create a hard floor below its policy rate, or the effective federal funds rate, currently in a target range of 0% to 0.25%. Eligible counterparties lend liquidity to the Fed in exchange for overnight Treasury guarantees.


The market is facing excess liquidity in the banking system due to the Fed’s asset purchases as part of quantitative easing and the US Treasury’s financial support to the economy in response to the pandemic.

The US Treasury must reduce its cash balance in the General Treasury Account (TGA) deposited with the Fed to a target of $ 450 billion before a two-year debt ceiling suspension expires on July 31. read more As of June 29, the Treasury has a cash balance of $ 711 billion, according to Wrightson ICAP data.

A reduction in the TGA increases the reserves of the banking system, which are now paid into the RRP market.


Raising RRP rates could reduce the demand of money market funds for US Treasuries, as the rates for the latter are at their lowest. For example, 3-month US Treasury bill rates are currently hovering below 0.05%.

Zoltan Pozsar, global head of short-term interest rate strategy at Credit Suisse, said the rotation of invoices to RRPs will not happen quickly because invoices are currently underwater, which means they are underwater. can only be sold at a loss.

“But will it happen,” he said.

Investors are also watching whether the amount of reserves and deposits that banks could lose to the RRP facility could be large enough to disrupt the dynamics of the interest rate market.

Lou Crandall, chief economist at Wrightson, believes bank cash outflows are not yet a problem.

If banks are worried about seeing excessive cash outflows because money market funds can earn 0.05% with the RRP facility, they can match that rate to hold their deposits, he said.

Reporting by Gertrude Chavez-Dreyfuss; Editing by Alden Bentley and Andrea Ricci

Our standards: Thomson Reuters Trust Principles.

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