Dropping Like a Stone: ON RRP Take-up within the Second Half of 2023

Gara Afonso, Marco Cipriani, and Gabriele La Spada

Take-up on the In a single day Reverse Repo Facility (ON RRP) has halved over the previous six months, declining by greater than $1 trillion since June 2023. This regular lower follows a speedy enhance from near zero in early 2021 to $2.2 trillion in December 2022, and a interval of comparatively secure balances through the first half of 2023. On this submit, we interpret the current drop in ON RRP take-up via the lens of the channels that we establish in our current Employees Report as driving its preliminary enhance.

ON RRP Take-up Has Been Reducing since June 2023…

Banks’ Stability-Sheet Prices

Because the Federal Reserve expanded its stability sheet in response to the COVID-19 pandemic, it elevated the provision of reserves to the banking system and, in consequence, banks’ stability sheets additionally grew. Reserves elevated from $1.6 trillion—or 9 % of banks property—in January 2020 to $3.2 trillion—or 16 % of financial institution property—over the next three months, reaching a historic most of 19 % of banks’ property in September 2021. Because the chart beneath reveals, financial institution property additionally grew from $18 trillion in January of 2020 to $20 trillion in April 2020, and continued to extend to $23 trillion in Might 2023.

As banks’ stability sheets increase, regulatory ratios—such because the supplementary leverage ratio (SLR)—are more likely to change into tighter for some establishments. Banks react to elevated balance-sheet prices by pushing a few of their deposits towards the cash market fund (MMF) trade—as an example, by decreasing the speed paid on financial institution deposits—and decreasing their demand for short-term debt. As we clarify in our paper, each results are more likely to have boosted ON RRP take-up throughout March 2021 – Might 2023, as most MMFs are eligible to spend money on the ON RRP and achieve this particularly when different funding choices, equivalent to banks’ wholesale short-term debt—together with repos by sellers affiliated with a financial institution holding firm—dwindle.

Probably, these results have subsided relative to 2022. Certainly, since June 2023, financial institution property have hovered round $23 trillion, barely beneath their March 2023 peak. Furthermore, reserves have been round 14 % of financial institution property since June 2023, beneath the typical of 16 % noticed between March 2020 and Might 2023. For the reason that SLR treats all property in the identical method no matter their riskiness, massive banks’ balance-sheet expansions are notably pricey if they’re used to finance protected property with low returns. Subsequently, although financial institution property have remained comparatively secure, the current decline within the ratio of reserves to financial institution property has doubtless diminished banks’ general balance-sheet prices.

…whereas Financial institution Belongings and Reserves Relative to Financial institution Belongings Have Remained Roughly Fixed.

Per a lower in banks’ balance-sheet prices (and a rise within the provide of financial institution debt), the rates of interest at which banks and dealer sellers borrow through in a single day Treasury-backed repos have elevated because the fourth quarter of 2022 and at the moment are a number of foundation factors above the ON RRP price (see chart beneath). This constructive price differential pushes MMFs away from investing on the ON RRP facility and into non-public repos.

The SOFR-ON RRP Unfold Has Been Optimistic…

Financial Coverage

Financial coverage can have an effect on ON RRP take-up by MMFs in two methods. First, the interest-rate pass-through of MMF shares is greater than that of financial institution deposits; in consequence, the scale of the MMF trade comoves with the financial coverage cycle as traders change from financial institution deposits to MMF shares when the coverage price will increase. Although the property of the MMF trade are at an all-time excessive, the tempo of the rise has considerably decreased not too long ago, according to a slower tempo of financial coverage tightening; furthermore, the share of MMF property managed by authorities funds—those probably to spend money on the ON RRP—has decreased since June 2022 by 7 proportion factors.

Second, financial coverage can have an effect on MMFs’ take-up on the ON RRP additionally via its impact on interest-rate uncertainty. Larger uncertainty leads MMFs to rebalance their portfolios towards investments with shorter period; the ON RRP is one such funding as it’s in a single day. Certainly, rate of interest uncertainty—as measured by the MOVE index—had elevated considerably through the newest tightening cycle, elevating from 57.3 in Might 2021 to 136 in Might 2023. Lately, nevertheless, the rise has been partially reversed. Certainly, the typical degree of the MOVE was 125.6 within the first half of 2023 however declined to 117.3 within the second half of the 12 months.

…whereas Curiosity-Price Uncertainty Has Been Reducing.

The Provide of T-bills

A 3rd driver of ON RRP take-up is the provision of T-bills. The Federal Authorities has expanded the provision of T-bills dramatically in 2023: T-bills excellent elevated from $3.7 trillion on the finish of 2022 to $5.3 trillion on the finish of September 2023, with a $1.3 trillion enhance since June. As the provision of T-bills grows, the funding choices of MMFs—and particularly of presidency funds, which characterize 83 % of the trade and might solely spend money on short-term authorities debt and repos backed by authorities debt—increase and, in consequence, their funding within the ON RRP dwindles. In our workers report, we estimate {that a} $100 billion enhance within the quantity of T-bill issuance reduces the proportion of ON RRP funding in a government-MMF portfolio by 2.3 proportion factors, relative to that in a prime-MMF portfolio; since common month-to-month T-bill issuance went from $1.12 trillion within the interval from 2022:Q1-2023:Q1 to $1.53 trillion in 2023:Q2-2023:Q3, this impact on portfolio rebalancing quantities to a further lower in ON RRP funding of roughly $350 billion.

Summing It Up

The rise in ON RRP take-up between 2021 and Might 2023 was pushed by a sequence of things: an increase in banks’ balance-sheet prices because of the enlargement of the provision of reserves in response to the COVID-19 pandemic, the speedy hikes in coverage charges aimed toward combating inflation and the ensuing enhance in interest-rate uncertainty, and the lower within the T-bill provide of 2021-22 ensuing from the normalization of public debt after the COVID-19  disaster.

These elements have reversed: the Federal Reserve restarted working off its stability sheet after the momentary enlargement through the banking turmoil of March 2023; the expansion of the banking system waned whereas the ratio of reserves to asset decreased; the tempo of interest-rate hikes slowed down; and the T-bill provide elevated once more. If these dynamics persist within the months forward, ON RRP take-up could proceed to lower. Such a gradual decline could be according to that noticed in early 2018, when funding on the ON RRP step by step disappeared because the Federal Reserve continued to normalize the scale of its stability sheet and reserves within the banking system turned much less considerable.

Gara Afonso is the pinnacle of Banking Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.

Marco Cipriani is the pinnacle of Cash and Funds Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.  

Gabriele La Spada is a monetary analysis economist in Cash and Funds Research within the Federal Reserve Financial institution of New York’s Analysis and Statistics Group.   

Methods to cite this submit:
Gara Afonso, Marco Cipriani, and Gabriele La Spada, “Dropping Like a Stone: ON RRP Take‑up within the Second Half of 2023,” Federal Reserve Financial institution of New York Liberty Road Economics, December 19, 2023, https://libertystreeteconomics.newyorkfed.org/2023/12/dropping-like-a-stone-on-rrp-take-up-in-the-second-half-of-2023/.