A modest return of liquidity means FOMC can focus on rate hikes
Money market funds switch from Reverse Repurchase Programme to banks
Money-market funds have moved some of their cash from the Reverse Repurchase Programme (RRP). This is an important development as it allows more (relative) liquidity to flow into the inter-bank settlement process - easing pressure on securities market liquidity. Is this move itself a reaction to the parlous state of liquidity in markets? Certainly any shift from money-market funds to banks would, inter alia, aid inter-bank liquidity, or at least slow the spread of illiquidity. The maybe not-such-good news, especially if you are a foreign borrower of dollars, is that improved market liquidity would reduce financial stability concerns, allowing the FOMC to focus its attention on the fight against inflation. That would mean probability skews towards further rate hikes. There’s no free lunch.
The parlous state of Treasury market liquidity has attracted particular attention (see this article in the Financial Times). US stock markets also recorded falls in turnover. The early plan outlined by the FOMC anticipated Quantitative Tightening(QT) to reduce RRP balances first. In fact, RRP balances remained exceptionally elevated. In part this reflected the effect on bank balance sheets of regulatory changes instituted post-GFC. Those regulations have not changed, yet banks appear more willing to face funds.
RRP has recently fallen somewhat - from an average of $2.2 trillion to just over $2 trillion. Looking at the volumes in repo there has been a corresponding switch from Triparty repo (blue line in chart below) to DVP repo (red line).
In addition, the interest rate offered by all repo types have risen somewhat relative to RRP rate (see chart below), suggesting banking system is prepared to offer higher rates for collateral, possibly in response to the fall in market liquidity. Early days, and the move is by no means conclusive, but taken together both these developments suggest commercial banks are more willing that previously to transact repo with money-market funds.
Why have banks become more willing to transact? Perhaps it was the decline in liquidity that prompted their change in stance. Perhaps it was some means of accommodating both regulatory restrictions and money-market funds on the balance sheets. It’s an interesting question to which we do not have any conclusive answer. But it’s probably good news for market liquidity.
