Federal Reserve Watch: Use Of Reverse Repurchase Agreements Grows

Summary

• The Federal Reserve's use of reverse repurchase agreements to offset its outright purchases of securities and keep the Federal Funds rate positive continues.
• At the end of the last banking week, September 29, 2021, the amount of reverse repurchase agreements on the Fed's balance sheet exceeded $1.7 trillion!
• And the Fed continues to buy $120.0 billion in securities, outright, every month.
• Tapering may start in November, but what kind of dilemma will the Fed be facing then, especially with all the reverse repurchase agreements that are outstanding?

GOCMEN/iStock via Getty Images

Over the past month, Federal Reserve balance sheet changes have been mixed.

Since September 1, 2021, the Federal Reserve has purchased, outright, $122.0 billion in securities, consistent with its efforts to buy $120.0 billion per month.

On the other side of the balance sheet, the Federal Reserve has sold securities under an agreement to repurchase them after a short period of time.

Since September 1, 2021, these reverse repurchase agreements on the Fed's balance sheet have increased by $326.0 billion.

So, during the past four weeks, the Fed has sold $206.0 billion more in securities than it has purchased. That is, the Fed, through the way it has managed it securities, has actually caused bank reserve to decline.

In addition to the reserves being put into the banking system and generating bank reserves, the Federal government has been writing checks on its General Account at the Fed. When the Fed writes checks, these funds end up in the banking system as bank reserves.

Since September 1, 2021, the U.S. Treasury's General Account has declined by $123.2 billion.

Totaling up these three accounts, the result comes out to be that the Fed has sold almost $81.0 billion more in securities than it has purchased or the government has released to the private sector by writing checks.

Overall, Reserve Balances with Federal Reserve Banks, a proxy for excess reserves in the banking system, have declined by $111.6 billion.

I have been arguing for quite a few weeks now that the Fed has been selling securities through the repurchase market in order to offset the liquidity being generated in the banking system by the Fed's purchase of securities in the open market and by the federal government paying back money to the private sector of the economy.

The Reason For Selling Securities

I have been arguing for many weeks now that the Federal Reserve has been pumping so much money into the banking system, buying $120.0 billion of securities each and every month, that it was putting excessive pressure on the Federal Funds rate and threatening to take the Federal Funds rate into negative territory.

This the Federal Reserve did not want that to happen.

Consequently, the Fed sold securities through the repo market to drain sufficient liquidity from the money markets so that the Federal Funds rate would stay positive.

Over the past month, the effective Federal Funds rate has remained constant at 0.08 percent.

The Use Of Reverse Repurchase Agreements

But to keep the effective Federal Funds rate at 0.08 percent, the Fed has had to make extreme use of the repo market.

Yes, the repurchase agreements are for just a very short time, a day, or two, or three. But in order to maintain a position in them, the Fed must continually be selling the securities once again after the securities come back on their balance sheet.

The total reverse repurchase agreements on the Fed's balance sheet on September 29, 2021, was $1,702.3 billion, or, $1.7 trillion!

A little over ten years ago, the total assets on the Fed's balance sheet was around $900.0 billion or about $0.9 trillion.

In the following chart you can see how the Fed has sold more and more securities under an agreement to repurchase them as the year has gone along and the pressure has built up on the Federal Funds rate to "go negative."

Note, that the buildup in these reverse repos only really began in late March and early April.

Reserve Balances with Federal Reserve Banks, the proxy for excess reserves, topped out a couple of weeks ago and now have declined for the past three weeks. The peak amount came in the week ended September 8, and totaled $4,259.6 billion.

One can see how these balances took off in the first quarter as the Fed's acquisition of $120.0 billion in new securities really began adding to the excess reserves of the commercial banking system.

Then, the Fed's use of reverse repurchase agreements started impacting the total, and the growth of Reserve Balances began to level out. Note even the "dip" in Reserve Balances that just happened to happen at the time that reverse repurchase agreements hit a "near-term" peak.

In recent weeks, you can see how the Reserve Balances have actually declined as the Fed's use of reverse repurchase agreements accelerated once again.

We have had all this talk about the Federal Reserve beginning to taper its monthly purchases of securities, but it seems as if the tapering has already begun, only with the use of reverse repurchase agreements.

What Will The Fed Do?

So, what is Fed Chair Jerome Powell and the leadership of the Federal Reserve going to do to actually start to taper the amount of securities its purchases each month.

Mr. Powell has already stated this week that if the inflation numbers don't start to moderate in the near future, the Fed will have problems adjusting its buying program.

What does he really mean?

It seems as if the Fed has already created a difficult situation for itself in its failure to begin the tapering exercise at an earlier date.

Now, the Fed not only has to deal with slowing down the purchase of securities, but it also has the problem of reducing its use of reverse repurchase agreements. And, what if the Fed must cause Reserve Balances with Federal Reserve Banks to fall in order to keep the Federal Funds rate in positive territory?

When might the Federal Reserve have to sell securities, outright?

I still believe that Mr. Powell and the Fed has maneuvered itself into a bad place. Mr. Powell, I believe, is going to have to make some very hard decisions in the future.

It has been very, very easy for Mr. Powell and the Fed to "err on the side of monetary ease," but the problem with that is that someday you usually have to work with the other side of the equation to make up for all the reserves that you have pumped into the banking system.

Mr. Powell and the Fed may be nearing this situation.

But, what if Mr. Powell is replaced by President Biden in February 2022 when his term expires?

Whoa! Another complication.

Analyst’s Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Comments

[bluescorpion0]

so you are saying Biden will replace Powell with a more dovish chairman who will keep rates low forever?

[dynx]

Maybe the political squawking about Powell as of late is actually from his friends? What a nice gift to be extricated from the problem by outside powers before the proverbial sh*t hits the fan.

[Samiamaustin]

So, John:
First: what will the Fed need to do to remain credible and solvent?
Two: What is the worst case scenario? What is at risk?Samiamaustin

[BeenHoldin]

You believe a lot of things that have been clear to many of us for as much as 18 months now.

Confused.

You worked at the Fed, yet you have absolutely no clue what the playbook is here. It was never going to be easy. RRPs also are an issue surrounding debt ceiling.

I’m pleased this article is less political, but I wonder who find this info particularly novel?

[wald22]

@BeenHoldin There is more to it here. I agree with you that RRPs are also an issue because of the debt ceiling, but there is another unsaid problem. The Fed is about to unleash a lot of liquidity heading into fiscal year to backstop Evergrande and others to stop the contagion from spreading. Keep in mind most of this is dollar denominated, and the Fed's job is to keep the value of dollar denominated debt from falling apart. The last few days, the Fed used RRPs to help it set up this unleashing of liquidity to come. To the Fed, if China goes down, so does the USA. To this day there is more money flowing to China via our multinational entities then there is going into USA. Nixon went to China to grow the dollar denominated empire.