RIP to RRP?

Peter Maiorano: The massive decline that you’re describing really lines up exactly with the increase in bill issuance that came after the debt ceiling crisis back in the summer. Once we got through that period and the Treasury was able to begin issuing debt, they issued quite a bit in the front end. The increase in Treasury bills was dramatic.

Bipan Rai: Welcome, everybody, to another edition of the X factor podcast. I’m your host, Bipan Rai, Head of FX strategy here at CIBC. It’s part of the job, I spent a lot of time these days focusing on the minutia and the plumbing of the financial system to extract predictive indicators for macro variables, and also the way flows are going to move. And one person that I wanted to have back on this podcast is, of course, Peter Marino, our resident expert on all things related to the US repo market. Pete, welcome back to the podcast.

Peter Maiorano: Hey Bipan, how are you? It’s good to be back.

Bipan Rai: I want to start off saying that there has been this sort of massive decline in the amount of funds that have been parked at the Fed’s overnight reverse repo facility. And of course, we’re going to get into that a little bit more as we go through this podcast. But can you just summarize for our audience and to those that are uninitiated, what this tool is and why it’s so integral to the way that the fed conducts monetary policy?

Peter Maiorano: Yeah, sure. Bipan the RRP came into being several years ago, and what created the need for it was that we were in a 0 to 25 basis point range on the fed funds target that the fed was targeting, and the repo market was beginning to trade on the very low end of that range. And in fact, at times threatening and trading somewhat below zero and at negative interest rates. That presented quite a dilemma for money market funds who are a huge supplier of liquidity into the repo markets. They take a lot of their short term cash and invest it in repo. And for them, anything approaching zero and certainly anything below that was a non-starter and made it very difficult for them to operate. So the fed, in trying to maintain the integrity of the floor of their range, created the RRP as a place where money market funds could deposit their cash with the fed and receive a set rate, and they set that rate at five basis points when the target was 0 to 25. In order to try to keep a floor on how low the repo market and or fed funds would go. And that worked quite well. You know, now we’re in a more normal interest rate environment, and the target is five and a quarter to five and a half. With the RIP rate now currently set at 530. They the fed has maintained that our p rate at five basis points over their targeted a floor. And so that’s sort of the genesis of the RRP, and the amount of money that is in the RRP is generally the amount of cash that money market funds have over and above what they can invest on a bilateral basis in the repo market with bank counterparties.

Bipan Rai: Since May, we’ve seen at least, if not more than a trillion in terms of funds that have been parked out to the RRP decline. Now, there’s a couple of channels through which this has happened. Can you walk our audience through the main causes for this decline in usage of the facility have been.

Peter Maiorano: Yeah, sure. The massive decline that you’re describing really lines up exactly with the increase in bill issuance that came after the debt ceiling crisis back in the summer. Once we got through that period and the Treasury was able to begin issuing debt, they issued quite a bit in the front end. The increase in Treasury bills was dramatic, and the uptake by money market funds in buying bills began earnestly, sort of as the bill rates were trading above the RRP rate and money market funds. You know, anything above the RRP that they can get that makes sense to them. The other factor that has sort of sped that process up, if you will, is we’ve come to what looks like the end of the Fed’s the FOMC hiking cycle, and that’s enabling money market funds to feel more comfortable about extending their duration and by even more bills even further out the curve if they so choose, with less concern that there’ll be a rate hike that puts those positions underwater.

Bipan Rai: Okay, excellent, and as we look forward, we’re currently, I believe, close to just under 900 billion in the facility right now. In your view, are there additional risks that we could see further outflows from here when it comes to the RRP facility and what would cause those here on out?

Peter Maiorano: I wouldn’t even use the terms risks, let’s say, in that if I recall, you and I, when we were discussing the RRP back when it went over a trillion for the first time, and then it went over 2 trillion and it was running at 2.5 trillion, I think was the peak. There was some conversation and talk back in those days that the fed cared about how much liquidity was being trapped in the RP, and was that an issue for them. And I remember in prior discussions with you stating that I didn’t think it was. Is an issue for the FOMC, and I didn’t think they regarded the balance in the RFP, whether it be high or low, to be indicative of any kind of issue or problem in the market one way or the other, and that it’s there as a facility that’s able to be used when it makes sense to be used. I think if that balance, if and when it goes back down to zero over time, I don’t think anyone is going to be concerned about it from the FOMC perspective for sure. I think, you know, you’re right. We’re below 900 billion now. We’re running around 870 billion in the RRP. I think that might blip up a little tomorrow possibly with the November month end. But then you’ll see it again begin to decline, most likely as we get into December, and the driver of that, again is just going to be continued purchasing of T-bills, I believe, by the money market funds, and I think it’s all quite natural. I think it makes sense for them as long as the t-bill rates continue to remain above the RRP, as long as that is the case, I think they’ll be natural buyers of bills.

Bipan Rai: So I want to circle back to what you said earlier, and I think this is a very, very important point now that the fed is getting closer to the end of the cycle. And let’s just assume they’re at terminal, you know, all of a sudden, then money market funds are a little bit more comfortable and say terming out their bill holdings. But if we look at, say, Treasury issuance of coupons from here on out, you know, they’re set to increase, at least from here until the end of Q1 of 2024, relative to what we’ve seen over the past five years. What does that mean in terms of the financial system that all of a sudden is flush with collateral? Will that have an impact on the repo space, and will that lead to additional flows out of the RRP facility and maybe into the repo market from here.

Peter Maiorano: As the supply demand dynamic, you know, ebbs and flows between the amount of collateral that’s out there that needs funding and the amount of cash available to fund it. You saw way back in 2019 when we had the quote unquote repo spike that occurred, and confluence of events led to that situation but, some of it was lack of balance sheet on the part of banks to disintermediate the markets and step in and provide balance sheet to take on more assets. You could run into a situation where repo rates begin to gravitate north and further the decline in the RIP balance. As that happens, the fed does have a standing repo facility in place that it didn’t have years ago. The SRF, which is there to sort of help alleviate any times of stress and the funding markets or the repo market and provide an ability for people to go to the fed with collateral and get funding from them. I do think as and when the RIP balances end up going down to zero, and there’s and there’s a lot of leverage in the system. You know, you could see a time again where repo rates traded a more elevated level. And and you might in fact see the standing repo facility come into play at some point.

Bipan Rai: Okay. Thanks for that, Pete. So that’s a very good point. So let’s say the RIP does go to zero and we still see more collateral in the system relative to cash available. You know, in your mind, how likely is it that we see a take up of the Fed’s SRF facility that’s been implemented to stem any sort of pain in the repo market, if it were to come to that?

Peter Maiorano: Yeah, I don’t think it’s a guarantee, you know, that that has to end up being used. I think it’s there as a safeguard against what happened in 2019, and I think it will help alleviate any stresses that could possibly occur. Like, I think what we’re describing is a situation whereby the supply dynamic of collateral versus cash could swing the other way and end up in a situation where there’s a need for more funding and more cash out there than is available from banks due to balance sheet constraints. And if that’s the case, then you could see the standing repo facility have to be used.

Bipan Rai: Okay. So I’ll ask you, Pete, as somebody that follows this market very, very closely, how likely is it that the RIP gets to below zero by the end of, let’s say, Q1 of next year?

Peter Maiorano: It’s an interesting topic and something that some colleagues and I had been chatting about here recently, even like by the end of the fiscal 23, where do you think it ends up? Is it over 500 billion at that point? Five, 600 billion? You know, we could see another drop of, you know, several hundred billion before the end of 2023, first quarter of 24. Does it start to drop below 500 billion? Possibly. I could see that happening as to when it actually gets to zero. Very hard to predict, but definitely picked up some pace in the last couple of months. And I could see that resuming sort of in the first quarter. So it’s going to be interesting to see where and when it does go. Going below 1 trillion was a big deal. There’s nothing to suggest that the trend down is not going to continue.

Bipan Rai: Okay so Pete, you know, having all this knowledge in mind, I can’t help but think about the similarities between where we are now and potentially what that could mean relative to where we were in 2019 because, you know, if you recall, at that point, the fed was winding down its balance sheet and it did lead to some dislocations in the money market space. I mean, do you think there’s a corollary to this time around? And are you concerned about the fact that, you know, once we get to a situation where excess liquidity has gone down by even more, whether or not the Fed’s hyper-aggressive program is potentially a risk at that point.

Peter Maiorano: I think it’ll be something that people in the market will be watching closely. And I do agree with you on the parallel to 2019. We’re in a situation where the Fed’s winding down its balance sheet with QT. Now, that’s what was going on in August leading up to the September spike in 2019. There were various events that were contributing, but certainly the balance sheet unwind of the fed was part of it. You know, I do see that analogy. I do hear it loud and clear and agree with it. I think there is some debate about when the fed will end QT this time around. Will they wait for the RIP balance to go to zero before they do so, or will they stop QT a little bit before that, or even after? You know, that remains to be seen. But I do think it bears watching. You know, the main difference, and we’ve talked about it already, though, is the standing repo facility that’s in place today that wasn’t there in 2019. And its purpose is to help alleviate those situations where things get out of whack. I’m comforted by the fact that that program is in place, but I do think it’s going to be a very interesting time to see how things behave.

Bipan Rai: Just for our audience. I mean, this is an important discussion to be had because for so long we’ve had to or at least monetary policy has had to recalibrate in this sort of system of ample reserves to everything Pete said so far, with respect to the funds that are parked at the RRP, and the closer and closer they get to zero, especially when the fed is shrinking its balance sheet via the quantitative tightening process. For us, that sort of look more on the cross-border space. We look at the foreign exchange rates and the like and demand for dollars in the financial system. I mean, if we do see, you know, a shrinkage of excess liquidity that potentially leaves less coverage for reserves to potentially absorb that excess supply that the fed is leaving off as part of the process, then, you know, that will potentially amplify the dollar scarcity effects that we see play out from time to time in the cross-currency space via a wider basis. So we are looking towards a scenario where that comes into sharper relief. And that’s one of the reasons why we’re monitoring the dynamics in the RRP space so closely these days. And we think it’s going to be a relevant topic for some time to come.

Bipan Rai: Pete, thanks again for joining us today. Again to our audience, you know, a lot of this subject matter, while esoteric, is still very germane to what’s happening in the macro space, especially when it comes to demand for dollars and how that filters through the foreign exchange space. The key thing to remember here is that, you know, if we see that excess liquidity dwindle and move towards zero, the RRP facility, that leaves a lot less coverage for a reserve. So that’s important given the fact that the fed is shrinking its balance sheet via the quantitative tightening process, as we’ve written about in the past and as we’ve spoken about in the past via these podcasts, if you do see a shrinkage in reserves, that does tend to amplify the scarcity effect when it comes to sourcing dollars. And again, that could lead to a wider cross currency basis, making it more expensive to source dollars in the FX swap space. And that’s one of the reasons, or at least one of the many reasons, why we think it’s important to pay attention to what’s happening with respect to the dynamics of liquidity in the financial system. We’re going to pause for now. Pete, again, thank you for stopping by and sharing your thoughts on the market, and we’d love to have you back sometime soon.

Peter Maiorano: Absolutely. Bepin. It’s always a pleasure to be with you and to spend time chatting about these issues.

Bipan Rai: Awesome. Till next time everyone.

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