This is the first time I’ve seen Wall Street banks calling for the Fed to give up on QE. The Fed is struggling to keep the liquidity it created from going haywire.
By Wolf Richter for WOLF STREET.
In the fall of 2019, when the repo market exploded, the Fed stepped in and bought Treasury and MBS securities and distributed cash through repurchase agreements. When these repurchases expired, the Fed got its money back and the counterparties got their securities back. The Fed also did so during the market rout in March 2020. But in July 2020, the last repo expired and unwound.
Now the Fed is doing the opposite, with “reverse repos”. The repos are assets on the Fed’s balance sheet. Repurchase agreements are liabilities. With these reverse repos, the Fed is now overwhelmingly sale Treasury securities to counterparties and taking their liquidity, thereby draining liquidity from the market – the opposite effect of QE.
This morning, the Fed sold $ 351 billion in Treasury securities through overnight reverse repurchases to 48 counterparties, surpassing the brief peak of late March 2020, and more than replacing the $ 294 billion in Treasury securities. yesterday that it sold via reverse repurchase agreements. at 43 counterparts and which matured and unwound this morning.
These repurchase agreements are a sign that the banking system is struggling to manage the liquidity that the Fed injects through its QE. And that’s part of why there is now clamor on Wall Street for the Fed to cut back on QE purchases because the banking system is now drowning in the cash banks have as reserves on their balance sheets. By buying treasury bills in the repo market, banks are reducing their reserves and increasing their cash holdings.
So on the one hand, as part of QE, the Fed buys $ 120 billion per month in Treasury and MBS securities. On the flip side, the Fed took back $ 351 billion via overnight reverse repurchases, reversing nearly three months of QE.
It’s the kind of crazy situation you run into when you take something to the extreme, like the Fed has done with its asset purchases, and you get all kinds of side effects.
The Fed addressed those reverse repos and mountain of reservations at the last FOMC meeting, and published a summary of the discussions in its minutes yesterday.
Reserves are cash that banks deposit with the Federal Reserve and that the Fed owes banks. They are a liability on the Fed’s balance sheet. The Fed pays interest (currently 0.1%) on these reserves. Reserves on deposit with the Fed have now climbed to $ 3.92 trillion:
In the FOMC meeting minutes released yesterday, the Fed addressed skyrocketing reserve balances and the huge demand for short-term Treasuries, which the Fed is helping to supply through reverse repurchase agreements.
The Fed also said in the minutes that “a modest volume of transactions” in the overnight reverse repo market “has occurred at negative rates.” In other words, these participants borrow money at negative rates from counterparties that take Treasury securities as collateral. This is how strong the demand for Treasuries is in this end of the market.
The Fed said this negative rate reverse repo trading phenomenon “seemed to reflect a lot of technical factors.”
And the Fed said in the minutes that it would “adjust” – likely increase – the rate it pays on reserves, likely at the next meeting (“more than half” of survey respondents were waiting there, she said).
He added that the reverse repurchases on his balance sheet will likely rise further. In the words of the minutes:
“The director of SOMA noted that the downward pressure on overnight rates in the coming months could lead to conditions that justify taking into account a modest adjustment in administered rates and could ultimately lead to a largest share of Federal Reserve balance sheet expansion channeled to ON RRP [overnight reverse repurchase agreement] and other liabilities of the Federal Reserve. “
Banks have poured reserves through reverse repurchase agreements previously in the era of large reserves, but this happened at the end of the quarter, and particularly at the end of the year. The problem lessened after the Fed started cutting its assets during the quantitative tightening in 2018 and 2019. But the peak we’re seeing right now is in the middle of the quarter:
This is the first time I’ve seen Wall Street banks calling on the Fed to quit QE as the banking system cracks and crumbles under the huge pile of reserves. And apparently, from the response leaked in the minutes, the Fed realizes you can only push QE this far before something big goes wrong with unintended consequences.
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