Demand for Fed Reverse Repos Rises as Treasury Cuts Bill Supply

Investors are ramping up use of the Federal Reserve’s reverse-repurchase-agreement facility as reduced Treasury bill supply cuts securities available in the money market.

The allotment at the central bank’s daily fixed-rate reverse-repurchase agreements, which are tri-party transactions conducted daily by the Fed Bank of New York, was $159.2 billion today, up from $129.8 billion yesterday, and the most since $242.1 billion on the final day of March. The Fed’s reverse repos, which are offered at a fixed rate of 0.05 percent, have helped stabilize money-market rates, countering the normal trend lower when supply of investable securities declines.

“The recent increase in participation has nothing to do with quarter-end, but rather due to falling bill supply,” wrote Thomas Simons, a government-debt economist in New York at Jefferies LLC, in note to clients today. “The reverse-repo tests have been effective in establishing a soft floor of five basis points under front-end rates. General Collateral repo rates slipped today below five basis points, which suggests to us that we will probably see higher participation in the reverse-repo program in the next few weeks.”

Borrowing Costs

The rate for borrowing and lending Treasuries for one day in the repo market has fallen this month, yet remains above the rate the on the Fed’s reverse repos. The general collateral finance repo rate for Treasuries averaged 0.054 percent today, down from 0.099 at the end of March, according to the DTCC GCF Treasury Repo index.

The Treasury has been cutting bill auction sizes as a result of an influx of cash from April tax payments. Bill supply fell by $120 billion between March 20 and April 17, according to Jefferies. The total decline in bill supply by May 22 should prove to be $271 billion, Simons wrote in the note.

Money market mutual funds’ holdings of Treasury repo averaged $220 billion from September 2013 to March 2014, which compares with an average of $180 billion between January 2013 and the start of the Fed’s program in September of that year, according to Barclays Plc.

The Fed is using the fixed-rate reverse-repo facility to improve control of short-term borrowing costs and help facilitate the eventual unwinding of monetary stimulus. The facility will allow the Fed’s eligible tri-party reverse-repo counterparties, which range from banks to broker-dealer to money market funds, to lend the Fed unlimited amounts of cash overnight in exchange for Treasuries.

While the Fed gained the ability in 2008 to pay interest on cash it holds in the form of excess reserves, currently at a rate of 0.25 percent, that tool has had limited effect in anchoring borrowing costs because only banks are able to earn such interest.

The per-counterparty daily allotment cap at the Fed’s reverse repo facility is $10 billion at a fixed rate of 0.05 percent. The counterparty limit was $500 million when the program began. Under the Fed’s current guidelines for the operations, the fixed rate can range from 0.01 to 0.05 percent.

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