U.S. repo market flirts with negative rates as Fed seeks to absorb excess cash

FILE PHOTO: The Federal Reserve building sits against a blue sky in Washington, USA May 1, 2020. REUTERS / Kevin Lamarque / File Photo

American markets

Gertrude Chavez-Dreyfuss

NEW YORK (Reuters) – Excess liquidity in the financial system has put pressure on overnight interest rates, in some cases pushing them to negative levels, which analysts say could prompt the Reserve federal government to raise the short-term rates it manages.

The overnight repurchase rate, which measures the cost of borrowing short-term cash using treasury bills or other debt securities as collateral, fell to -0.06% at the end of March and fell to -0.06% at the end of March. hit that level again on Wednesday, before stabilizing around 0.01% on Friday.

The United States Guaranteed Overnight Funding Rate (SOFR), a short-term benchmark rate replacing the benchmark London Interbank Offered Rate (LIBOR), has been stuck at 0.01% since around March.

Analysts said the Fed is keen to prevent SOFR from turning negative because it has significant operational issues with its components.

As short-term rates have continued to approach negative levels, expectations are growing that the Fed may soon raise the rate it charges for loans to non-banks during its reverse repo window. currently at 0%, as well as the interest it pays to banks for surpluses. reserves (IOER), which is 0.10%.

Lorie Logan, executive vice president of the New York Fed and head of the Open Market System (SOMA) account, said on Thursday that the Fed is ready to adjust the rates it sets if necessary, echoing the comments that she did last week.


The Fed launched its reverse repurchase agreement (RRP) program in 2013 to absorb additional liquidity in the repo market and create a hard floor below market rates, especially its policy rate. Eligible counterparties lend liquidity to the Fed in exchange for overnight Treasury guarantees.

At the March meeting, the Fed raised the amount that counterparties can lend to $ 80 billion, from $ 30 billion.

So far this week, the Fed has absorbed about $ 148 billion in excess liquidity through the RRP window.


In a repo transaction, a borrower offers or sells US Treasuries and other high-quality securities as collateral to raise cash, often overnight, to fund its trading and lending activities. The next day, they pay off their loans plus what is usually a nominal interest rate and collect their bonds. In other words, they buy back, or repo, the bonds.

Since overnight repo rates turned negative a few times in February and March, investors often looked to the Fed’s RRP window where the rate is set at 0%.

Lenders in the repo market typically include money market funds, insurance companies, corporations, municipalities, central banks, and commercial banks that have excess liquidity to invest. On the other hand, brokers and deposit-taking institutions borrow cash against long positions in securities to finance their stocks and balance sheet position.


The federal funds rate is the rate that banks charge each other for overnight loans to meet the reserves required by the US central bank. The Federal Open Market Committee (FOMC) sets a target level for the federal funds rate, currently in a range of 0% to 0.25%. The federal funds rate is currently 0.07%.

The federal funds rate is an important factor that determines other interest rates such as those on credit cards, mortgages, and bank loans.

The federal funds market has generally facilitated the transfer of the most liquid funds between banks. The New York Fed then uses open market operations to adjust the supply of reserves in the system which, along with the IOER, influences federal funds overnight to trade within the target range.

Interest on Reserves (IOR) is the rate paid by Federal Reserve banks on reserve balances held by deposit-taking institutions in their local federal banks. One component of the IOR is interest on minimum reserves, currently at 0.10%.

The New York Fed has said on its website that paying interest on reserve requirements removes the opportunity cost that banks incur by not investing those reserves in interest-bearing assets.


The other component of the IOR is the excess reserve interest or IOER, which is the interest paid on balances above the level of reserves that banks are required to hold. The 0.10% IOER payment reduces the incentive for banks to lend at rates well below that rate and provides the Fed with additional control over the federal funds rate.

Historically, the Fed has tended to adjust the IOER when the fed funds rate is within 5 basis points of the upper or lower limit of the target range.

When the Fed lowered its policy rate in March 2020 to zero in the midst of the pandemic, it also reduced all the rates it administers to zero.


The cash surplus was in part due to massive asset purchases from the Fed and support from the US Treasury to deal with the coronavirus pandemic.

The US Treasury is also moving away from issuing short-term bonds and moving towards longer maturities to fund fiscal stimulus, putting pressure on yields on initial and repo rates.

The Fed’s withdrawal by the Treasury has been significant in recent months. By early February, treasury balances stood at around $ 1.7 trillion. That amount has since fallen to $ 1 trillion, analysts said, which means $ 700 billion in extra liquidity in the financial system and more bank reserves that need to go somewhere.

© 2020 Reuters. All rights reserved.

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