There’s a Rush for the World’s ‘Safest’ Dollars, Deutsche Bank Says

Behold, the rush for the world’s safest dollars!

That shows balances at the Federal Reserve’s overnight reverse repurchase agreement facility, or RRP, which have surpassed the $2 trillion dollar level for much of the summer.

And while demand for ‘normal’ dollars has of course increased markedly in the same timeframe, with the Bloomberg Dollar Spot Index up around 10% this year, it’s the rush into this particular Fed facility that shows the forceful way in which investors are shifting into safe havens, according to Deutsche Bank AG strategist George Saravelos. That’s happening against a backdrop of a European energy crisis that has sent the euro and risk assets tumbling.

“Investors are currently placing more than $2 trillion dollars in overnight liquidity with the Fed, a more than $1 trillion rise since this time last year,” Saravelos said in a note published on Tuesday. “From a top down macro perspective it can be argued the surge in RRP usage boils down to one thing: an immense demand for ‘safe’ dollar assets. By offering what is essentially a collateralized interest-earning overnight deposit at the Fed with zero duration and credit risk, the Fed’s RRP facility constitutes the safest dollar asset in the world. And demand for such an asset currently appears immense.”

Of course, there are some who view the RRP as just a reflection of liquidity sloshing around the system, creating a sort of ‘overflow’ area that allows excess cash that can’t be handled by balance sheet-constrained banks to flow into money market funds instead. The facility lets big investors, including money market funds, park that excess cash at the Fed overnight and earn interest.

As the Fed raises benchmark interest rates, money-market funds have been eager to put cash into the facility. Meanwhile, some analysts expect balances at the RRP to tumble as the US’s government-sponsored entities distribute funds to holders of mortgage-backed securities. “Usage should decline in the coming days as the GSE’s pull the cash out of the RRP facility to make MBS payments on the 25th,” Citigroup Inc. economists Isfar Munir and Jason Williams pointed out last week.

But for Saravelos, RRP balances are a sign of liquidity being pulled away from other assets. He suggests that usage of the facility shows “just how powerful the safe-haven demand has been.”