(Bloomberg) -- Declining demand for a key Federal Reserve liquidity facility is near a point of resistance thanks to recent regulatory changes that force certain US money-market funds to keep more cash on hand.
Demand for the Fed’s overnight reverse repurchase agreement facility, or RRP, dropped on Tuesday to $238 billion — the lowest since May 2021 — from $261 billion the prior session, according to New York Fed data. It’s the latest in a string of declines since usage of the RRP spiked in late 2022, drawing into question the outlook for the central bank’s balance-sheet runoff.
For now, however, this year’s changes by the Securities and Exchange Commission underscore potential limitations at play in the $6.47 trillion US money market industry, notably affecting prime funds.
The funds, which tend to invest in higher-risk assets such as commercial paper and certificates of deposit, have increased their share of the RRP to about 31% of the total as of the end of September, up from 18% a year ago, Office of Financial Research data show. But that may be close to stabilizing as new rules governing the industry force funds to boost liquidity requirements to protect against market turmoil.
If this demand has actually peaked, it means that bank reserves will ultimately start draining faster, leaving market participants to wonder how much further the Fed can shrink its balance sheet before liquidity in the system reaches a point that’s considered too scarce.
“There’s certainly an incentive for those funds to use RRP, but I also don’t think the Fed is so keen on reaching RRP zero that they are willing to really change money market rates dramatically,” said Gennadiy Goldberg, head of interest rate strategy at TD Securities.
Overall use of the reverse repo facility has declined by more tha $2 trillion since its peak in December 2022. Meanwhle, prime funds’ increasing share suggests that while a majority of counterparties are keen to shift cash away from the RRP in favor of higher yielding short-term assets, some are content to continue parking funds at the central bank.
Dallas Fed President Lorie Logan said Monday at the Securities Industry and Financial Markets Association’s annual meeting in New York that it would be appropriate to operate with only “negligible balances” in the reverse repo facility, though she acknowledged some demand may be stickier as users value overnight assets or face counterparty credit limits for repo in the private market.
In fact, RRP balances last flatlined around $400 billion in July even as repo rates climbed. That inertia was driven by a combination of primary dealer balance-sheet constraints, which limited their ability to take in triparty repo cash, limited access to the Fixed Income Clearing Corporation’s sponsored repo platform, as well as uncertainty about the trajectory of the Fed’s path for interest-rate cuts. Demand eventually resumed its decline to hit a multi-year low on Tuesday.
Logan also surmised if the remaining RRP balances don’t depart as repo rates rise then policymakers could reduce the offering rate on the facility — currently 4.8% — to incentivize participants to shift to private markets.
“It could certainly make funds think twice about keeping liquidity in RRP,” TD’s Goldberg said. “Outright yield matters and while the asterisk about liquidity might be important, it ultimately fails to compete with cold, hard, yield.”
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