The Federal Reserve has made it clear since the end of 2024 that the ‘hawks’ turn is complete. Until that moment, the future seemed like a succession of interest rate cuts due to the rapid decline in inflation and a gradual cooling in the labor market. However, Powell proclaimed that, faced with a possible reflation due to Trump’s rise, the central bank would continue to keep its shield at the top and would barely move the price of money, supported by a still very resilient economy and employment that is not giving up a bit. millimeter. The projections of its roadmap (dot plot) pointed to two cuts in all of 2025, while the swap market’s most likely option is that there will be a single cut of 25 basis points throughout the year.
In this restrictive monetary context, the Fed has made a ‘phantom’ move that has gone under the radar. A change that he hopes will ‘go against’ the spirit of maintaining the cuts. While the price of money will continue to pressure the economy, The institution has sought to use another, much less known tool to do the opposite.expand the credit offered by the banking sector in the economy and thus offer support to the growth of the North American giant. The weapon that is being wielded from the shadows, the reverse repo market.
This is, neither more nor less, than a ‘window’ of the Federal Reserve where banks and all types of financial institutions park their money in exchange for an interest of 0.05%. The use it has is to deposit the excess money from daily operations, which for a time became a great thermometer to measure the liquidity in the market. The tool was born in 2013 but its time did not come until 2021. At that time lThe injection of liquidity that the Fed made after the covid flooded the market and, to avoid major disruptionss, the central bank removed the daily limit that applies to this tool.
In this way, even though Reverse repos were initially used to cover temporary daily liquidity problems, from then on it became a real financing tool for banks at very cheap prices. Its importance reached such a point that it exceeded the 2.5 billion dollars accumulated in these windows. Since then it has not stopped declining but in recent months this decline had stagnated, a trend that the Fed wants to break, since they do not seem to be comfortable with the amount of money that is still present in this tool.
That is why in its last meeting the Federal Reserve changed the parameters of this tool two weeks ago, in the middle of the Christmas season. Specifically The central bank reduced the ‘rate’ of reverse repo lower range of general interest rates i.e. to 4.25%. This is the first time it has fallen to the lower range since 2021, thus executing a decrease of 5 basis points in one fell swoop. With this movement, The Fed seeks to make it less profitable for institutions to leave their money at the central bank window and move that money into the economy through credit..
The result has been clear. In record time, funds in reverse repos have fallen to $100,000 according to the latest data published by the New York Federal Reserve. Although the figure had already been falling all year, the pace had clearly slowed down in the final stretch of 2024.
“This is the natural result of the Fed’s decision to realign with the lower bound,” said John Canavan, an analyst at Oxford Economics. “Not surprisingly, the decision to reduce the relative rate, making it less attractive compared to alternatives, contributed to the broader trend of decline we were seeing in reverse repos.”
However, this has gone directly to the fixed income market. At least that’s what the experts at Deutsche Bank think. In his latest report, Steven Zeng commented that “reverse repos are now several points below bills maturing in 1 and 3 months.” Therefore, “investors are probably changing this formula for these securities.”
For James Knightley, of ING, the Fed’s initiative “reduces the compensation obtainable at the reverse repo window, and should lead to lower usage”. Having a buffer of 5 basis points “made sense when the interest rate floor was zero (to avoid a zero impression). Now there is no buffer, but it is not necessary either.” The effective funds rate “should not be affected, although there may be a downward bias.”
Guggenheim analyst Patricia Zobel explains that the measure “is effective in encouraging people to find alternatives to parking money at the Federal Reserve and will likely also reduce money market pressure.” From TD Securities they defend that “some money funds use repos as a source of liquidity due to the ease of entering and exiting the facility on a daily basis, especially at the end of the day if they have capital inflows on the last day”. Therefore, “we believe that reducing (repo) rates will increase the opportunity cost of holding the cash there.”
From Axa they added that “we must take note of the Fed’s decision to lower the reverse repo rate again to the lower end of the range.” Although Powell was not asked about this, “we suspect it is in an attempt to facilitate further reduction of holdings at the Fed and allow the Fed to squeeze more reserves out of the system.”
In any case, this strategy is just a nuance to the general direction of the Fed. In fact, while the central bank seeks to release the gigantic mountain of cash that was formed in this window, the reality is that it will continue to drain liquidity through its balance. “The consensus on Wall Street is that the quantitative adjustment (the stimulus program through purchasing public debt) ends this March 2025,” comment the experts from the Official Monetary Institutions Forum (OMFIF, for its acronym in English).
According to the Think Tank, “lThe minutes of the Federal Reserve’s November Federal Open Market Committee meeting revealed that several participants believed that this presence in the Treasury securities market remained a risk and commented that it would be important to closely monitor the evolution of the resilience of the Federal Reserve. market“. From Guggenheim they point out that, in this way, “harmonizing the reverse repo spread now helps to gain flexibility while continuing to get rid of its bond holdings.”
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