This officially drains the Reverse Repo Facility

This officially drains the Reverse Repo Facility

for the very first time since June of

2021 the Federal Reserve has made a

change to the reverse repo facility that

should completely drain it once and for

all this is a chart of the reverse repo

facility at the Federal Reserve and you

can see starting in 2021 a bunch of cash

started flooding into this facility

until it topped out in 20122 around $2.3

trillion so let me explain the way that

Why and how the Fed made this change

the Federal Reserve caused all that cash

to flood into there and the reason why

they did it initially in 2020 when all

of the money printing started the

reverse repo facility was set at a 0%

interest rate just like the federal

funds rate was but a couple of

unexpected things happened as a result

of the monetary and fiscal policy number

one the Federal Reserve doesn't just

print money and hand it out they do

something with it which is purchase

assets onto their balance sheet the

majority of those assets are treasuries

that they buy from Banks so the federal

reserve prints a bunch of of cash they

buy treasuries from Banks those Banks

can then turn around and loan that new

cash directly back to the US government

creating new treasuries what the US

government then does with all that cash

is it spends it in the form of stimulus

checks PPP loans and other spending

programs as a result of this the economy

the financial system has two things that

happen simultaneously number one it gets

flooded with the newly created cash it

went from the FED to the banks to the

government and and then spent into

people's bank accounts so a lot of new

cash hits the system but the second

thing that happens is the financial

system itself has a lot fewer Assets in

order to offset that cash if you want to

know what I mean consider this when you

put money in the bank it is your asset

because the bank owes you that money but

to the bank it is now a liability

because they owe you that money just as

if you owe somebody else's money it's

your liability so they have to go do

something with that cash in order to

offset that liability which is buy an

asset the problem is the Fed just spent

the last couple of months buying up all

the assets out of financial system the

few assets that were left to be bought

were being bought up at higher and

higher prices as these assets are debt

that means once you get over 100% you

start to tip the interest rate or the

yield on that debt negative meaning if

you have an IOU from the federal

government that says the federal

government will pay you back $100 and I

pay you $101 for that I'm still only

going to get $100 from the government

when they pay that back but because I

paid you $101 and I get $100 back my

interest rate is now negative so to

recap the Federal Reserve created a

bunch of money bought treasuries from

Banks so less Assets in the system the

banks lent that money to the government

the government spent that cash back into

the economy so now the financial system

has a lot more cash and a lot fewer

assets the banks go looking for assets

to buy in order to offset all these

deposits and there's not enough so the

Federal Reserve says okay we got to do

something about this we'll use the

reverse repo facility and allow that

cash to be lent back to the FED in

exchange for temporary collateral all

the collateral that the FED just bought

up out of the system in order to

How the Fed Incentivized Cash into Reverse Repo

incentivize that cash to be placed into

the reverse repo facility in June of

2021 they increased the interest rate

that was being paid on this cash to five

basis points above the lower end of the

FED funds rate so here is the chart of

the federal funds rate you can see all

throughout 2020 and 2021 and even into

2022 to the federal funds rate was held

between 0 and

.25% however during that time frame from

June of 2021 all the way until February

of 2022 the interest rate being paid out

for cash held in the reverse repo

facility was

05% in other words if you are a bank you

get a bunch of deposits it is free money

you take that cash give it to the

Federal Reserve temporarily and you get

paid 05% in exchange for that you get

the collateral that you need to offset

the liabilities these are repurchase

agreements that can be Unwound at any

time and so it is just like reserves

they're able to unwind that if they need

to meet deposits or withdrawals this was

obviously very lucrative for banks which

is why it sucked $2.3 trillion into the

reverse Rebo facility over the next few

years and the kicker here is that once

the Federal Reserve started trying to

fight inflation they were raising

interest rates they had to keep that 05

difference so that they were paying a

premium into their the reverse repo

facility so that all that cash didn't

just flood back out into the financial

system causing more stimulus now they're

trying to fight inflation making sure

that stimulus doesn't go out into the

economy they don't want that cash out

there being used for productive purposes

they want to keep that cash locked away

in the reverse repo facility where it

can't be used so they're literally

paying Banks hundreds of billions of

dollars just to hoard that cash with the

FED overnight and not do anything

productive with it so let's look at

these two charts overlay on top of each

other you can see the lower bound of the

FED funds rate and the reverse repo rate

Contin to stay in lock step with the

reverse repo rate being just five basis

points higher than lower bound to the

FED funds rate all this entire time and

even recently once the Federal Reserve

began to lower rates again it was still

in lock step let's zoom in here on the

most recent action you can see a little

bit of separation between the lines you

can see that up until a few weeks ago

the lower bound to the federal funds

rate was at 4

4.5% however the reverse repo rate was

at

4.55% so for years now they wanted to

make sure that cash stayed inside the

reverse repo facility and didn't all

flood out at once but now you can see

they have changed that policy both the

reverse repo rate and the lower end of

the federal funds rate are locked

together at

4.25% now which means there is no longer

any incentive to keeping your cash in

the reverse repo facility compared to

Alternatives and yes there's only $98

billion left in the reverse repo

facility at this point it is almost

drained there's no longer any reason to

keep excess cash in the reverse repo

Where the excess cash will go next

facility instead that cash will be

sucked out into the t- bill market and

you can see right now t- bill rates have

been falling and they will probably stop

falling just right above that

4.25% Mark because at the end of the day

there's still a little bit of extra risk

with something like a t- bill versus

going directly to the money printer

itself the Federal Reserve that tiny bit

extra risk commands a tiny bit extra

premium on the yield so the question is

Why now?

why now well number one it's because the

reverse rippo facility is almost

entirely drained already and so its

impact on markets is going to be

negligible what's another 98 billion

thrown into the t- bill Market really

nothing at all but number two it

highlights the fact that the Federal

Reserve is no longer concerned about

withholding liquidity from the market

yes they are still trying to combat

inflation but they are battling the

hurricane of inflation on one side with

the earthquake of a deflationary death

spiral and a government default on the

other side which way do you think

they're going to lean the Federal

Reserve will always lean towards a

little bit extra inflation so they don't

want to floor under interest rates

anymore they want to continue to be able

to save face with their balance sheet

and quantitative tightening and maybe

slowing down on interest rate Cuts but

in my opinion they are changing

direction a little bit too early

inflation is still much too elevated and

many measures are showing inflation is

actually turning around and heading

higher which means the FED will probably

have to pause rate Cuts entirely here

may not cut at all next year and could

in fact even turn back around and start

hiking again in a repeat of what

happened during the 70s starting cutting

too early into inflation having to

change course and try and get back in

front of inflation again all in an

effort to really try and help the

government to not default which we all

know is a lost cause especially if you

are just counting in terms of purchasing

power so at least for right now it looks

like the reverse repo Saga has finally

come to an end as they've removed the

premium to suck cash or keep cash inside

that facility to allow the last little

drags of that liquidity to go back out

into the t- bill Market to help out the

government with their finances just a

tad bit more as always