The Fed’s Reverse Repo (RRP) operations act primarily as a money market fund for money market funds (MMFs.) The MMFs were forced out of their T-bills in 2021-22 because the US Treasury was paying them down. The Treasury redeemed the T-bills and the MMFs got cash back. Not what they wanted. They need to earn interest on those funds. Non-subscribers, click here for access.
The MMFs were therefore in trouble. The Fed came to the rescue by opening its RRP operations to the MMFs. Previously, only Primary Dealers could participate. In effect, the Fed began subsidizing MMFs. As the Fed raised the rate it paid on RRPs, that increased the subsidy to MMFs, and their holders, mostly big investors. Non-subscribers, click here for access.
In this program, the MMF’s could place their excess cash with the Fed overnight and get a nice big fat, risk free, interest payment in return. The Fed imagines that money into existence. Non-subscribers, click here for access.
But the interest payments cut into the Fed’s surplus (aka profit). If the Fed loses money, that reduces the amount of surplus and ultimately, the taxpayer ends up paying for that. Nice. Taxpayers fund welfare payments to MMFs which are typically held by the wealthiest of the wealthy anyway. Therefore the Fed’s interest payments on RRPs are welfare for the rich. Non-subscribers, click here for access.
But I digress.
Once the RRPs were opened up to MMFs, RRPs outstanding ballooned. They got up to $2.6 trillion when the Fed rescued those couple of failed banks in March. Non-subscribers, click here for access.
Meanwhile, I have constantly warned that when the debt ceiling was lifted and the US Treasury started issuing T-bills again, MMFs would pull cash from RRPs to buy T-bills. It’s now happening. RRP balances have fallen by $275 billion since May 24, as the Treasury has been issuing wads of T-bills, including a net of $175 billion this week. Non-subscribers, click here for access.
The RRPs aren’t funding all of that, but they’re absorbing most of it. With T-bills being perfect collateral, they can be, and are, used for repurchase agreements from banks (RPs) whereby the bank will provide credit up to nearly the amount of the T-bill. RPs are like margin loans in that respect, except that the haircut is almost nothing. So the reintroduction of T-bills into the market provides collateral for more credit. More credit means more money to buy hot paper. Non-subscribers, click here for access.
And they’re buying it. Non-subscribers, click here for access.
Some of you have pointed out correctly that MMFs, particularly government MMFs, can only buy T-bills with their cash. But MMFs are only intermediaries. Who holds MMFs? That’s right, major investment institutions, hedge funds, and you and me, aka Ma and Pa investor.
We investors, both big and small, participate in the Fed’s RRP program through these intermediaries. And when we as a group start feeling bullish on balance, for no reason in particular, then we pull money out of MMFs and buy stocks, bonds, real estate etc. etc. etc. Non-subscribers, click here for access.
That’s what is happening now. The rationale for it DOES NOT MATTER. The fact that interest rates are higher now than last October when stocks bottomed, DOES NOT MATTER. The fact that the Fed is still steadily tightening monetary policy via QT DOES NOT MATTER. Non-subscribers, click here for access.
QT will matter.
I’ll tell you when, and why, and what it will mean for your dining, listening, and investing pleasure. Non-subscribers, click here for access.
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