The Fed, the new preferred repo counterparty in times of tension
|Two tools, a corridor for short-term market rates
In July, the Fed supplemented its monetary policy toolkit by creating a permanent repo facility (Standing Repo Facility or SRF) to complement its reverse repo facility (Reverse Repo Program or RRP1). In contrast to firm purchases or sales of securities, these allow the temporary sterilization (RRP) or injection (SRF) of central bank liquidity. The two facilities aim to create a corridor for short-term market rates, and more specifically for the (private2) repo lending markets. The aim is to be able to attenuate situations of excess or insufficient liquidity and thus ensure good transmission of monetary policy. These (private) markets concentrate very large trading volumes (more than USD 4,000 billion in outstandings in 2021 according to SIFMA) and are one of the main sources for day-to-day refinancing and cash management for US financial institutions. In addition, the effective Fed Funds rate, which determines a large swathe of interest rates for loans to consumers and companies, is highly sensitive to changes in the cost of repos3. Lastly, the median repo rate (Secured Overnight Financing Rate, SOFR4) will serve as the main benchmark rate for new derivatives contracts in the US from 1 January 2022.
RRP: Draining off reserves and providing a floor for short rates
Under the RRP the Fed places Treasury securities it holds on its balance sheet on repo with counterparties (banks, primary dealers, Government Sponsored Enterprises, and money market funds). By using this facility, banks and non-banking institutions make a secured loan (cash against Treasuries) to the Fed. Another way of interpreting this transaction is to consider that a financial institution makes a ‘deposit’ with the Fed in exchange for the transfer of ownership, for a predetermined period, of the securities provided as collateral. This type of transaction transits through bank balance sheets such that it reduces the reserves that banks hold with the Fed. The Fed records the reverse repo in its liabilities as a debt and debits the current account of the intermediary bank (central bank reserves) for the same amount. When a bank enters into a repo transaction with the Fed, the transaction results simply in an exchange of assets on its balance sheet (reverse repo against reserves) with no effect on its overall size. Where a bank is acting on behalf of a money market fund, it debits the deposit account of its client, and its balance sheet is reduced (reduction both in reserves on the asset side and in deposits on the liability side).
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