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While we have seen US employment numbers missing the mark of late, a peculiar development has occurred in the markets. That is the size of reverse repos that have been placed at the US Fed. But, first, we need to ask the question of what a reverse repo is? The repurchase agreement (repo or RP) and the reverse repo agreement (RRP) are two key tools used by many large financial institutions, banks, and some businesses. These short-term agreements provide temporary lending opportunities that help to fund ongoing operations. The Federal Reserve also uses the repo and reverse repo as a method to control money supply. Thus from the above, it follows that should the Fed engage in reverse repos, it is in effect draining money from the system in an event to control money supply. This is done to battle on two fronts; both fronts are rooted in an oversupply of money. In the past couple of weeks, all the excess liquidity provided by the Fed in the form of QE has been taken back by the Fed through the Reverse Repo market. The first reason is to curb inflation, which has been a buzzword in the US economy of late. The Fed, however, has stated that inflation will be transitory and that inflation should be back around the 2% level by years end. The second reason is that Banks are sitting on too much cash with no place to park it as the oversupply in money will lead to the short end of the yield curve turning negative with the Fed keeping cash at 0%. With the US increasing liquidity due to COVID, it is easy to see that this battle could go on for a while and will be key going forward. |
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From the graph above, it is easy to discern that Reverse Repos picked up the past couple of months, just as the US tries to move out of the pandemic. For example, yesterday (8 June), we saw a new record reverse repos of $497bio. While most market commentators see this as temporary until net issuances of Treasuries are picking up again, taking cash from the Fed. In other words, US Treasury spending is lower than QE, which leads to some skewness in the market. With inflation currently becoming the biggest concern in the US economy, we will watch this development closely. At some stage, QE needs to be scaled back to curb the supply of money, or will the Reverse Repos be the desired avenue to wane the US economy of QE without calling it? In effect, the Fed is doing yield curve control not to become Japan or the Eurozone with negative interest rates and the possibility of disinflation. Therefore the big emphasis on the US CPI number published tomorrow. |
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This opinion piece was researched and written by Andre Botha, a Senior Treasury Dealer at TreasuryONE. You are welcome to phone or email us and discuss your view on the topic. |