The grim repo

S2N spotlight

The Federal Reserve’s overnight reverse repurchase (RRP) facility—once a colossal reservoir of liquidity, routinely soaking up around $2–2.7 trillion at its peak—is now dwindling towards the brink of zero.

So, what does this mean?

The RRP facility is essentially the Fed’s way of storing excess cash from money-market funds and institutional investors by offering a safe short-term return—often more enticing than what banks provide. This “cash parking” quietly helped the Fed manage liquidity in the system. Think of it like a mop soaking up excess water after a storm. (Sydney, fittingly, is experiencing its heaviest rainfall in more than 125 years.)

But now that nearly $2 trillion in this “Fed savings account” has been unwound, where has it gone? A big chunk has flowed into U.S. Treasury T-bills, which are short-term, low-risk, and lately offering slightly higher yields than the RRP facility. Since July, money-market funds have steadily redirected capital from the Fed into these Treasury bills.

With the RRP nearly out of the picture, the question is: where do the next waves of market investment come from? The natural candidate is banks’ reserves. But here lies the risk: if reserves drop too quickly, it can trigger dislocations in funding markets. We saw a glimpse of this in September 2019, when a sudden shortage of reserves caused the overnight repo rate to spike to nearly 10%, forcing the Fed to step in with emergency liquidity.

That episode is a reminder: when the liquidity “mop” runs dry, stresses can surface suddenly. Which makes today’s dwindling RRP balances not just a technical footnote but a potential turning point for financial markets.

Don’t stress, Signal2Noise will be watching for any early warning signs. By the way when will this rain stop? It feels like it is never-ending.

The corporate bond market doesn’t seem to be one bit worried. This is a trade I have been keen on for about a year that has not yet started paying its way. Junk bonds have been trading like growth stocks. I am seeing enough of an uptick in corporate bankruptcies to think this trade idea has plenty of legs.

S2N observations

A fitting order of performance? I always wanted Platinum Frequent Flyer status. Gold seems to get all the attention.

You have seen me share this chart many times. I don’t take any notice of all the probability calculations of a cut in September or December and the endless noise around these MPC meetings. The 2-year is my compass.

For some reason I have been incredibly persistent with my long Chinese stocks and short the US. It looks like there is still plenty of room left with this trade. For newer subscribers I have preferred to play this out with the Hang Seng, as it is less prone to manipulation than the mainland Shenzhen exchange.

The short Hang Seng long US has been harder to hang on to; we nearly got stopped out.

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Shoot, coffee just got a double shot. My addiction is going to bankrupt me.

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