(Bloomberg) -- The amount of money at a key Federal Reserve facility could stall at around $300 billion amid ongoing pressures in the overnight dollar funding markets, according to Citigroup Inc.
A combination of factors have kept levels essentially the same — elevated Treasury issuance and primary dealer capacity issues. On Monday, some 64 counterparties put $329 billlion at the central bank’s overnight reverse repurchase agreement facility, or RRP, which is used by banks, government sponsored enterprises and money-market mutual funds to earn a market rate — the highest level since Aug. 2.
“We could be at a constraint level again, this time at $300 billion,” Citi strategist Jason Williams said in a note dated Aug. 9.
Last week, RRP balances sank to the lowest level since May 2021. In July, money parked at the Fed was steady at around $400 billion.
Treasury issuance has swelled in recent years to fund government deficits and replace securities rolling off the Fed’s balance sheet as part of its quantitative tightening, or QT. As a result, primary dealers have had more supply to digest and with their holdings near all-time highs, their normal function as an intermediary in the market is limited.
That means that even if counterparties wanted to shift out of the RRP to take advantage of higher overnight rates, dealers may not have the capacity to accommodate more activity.
However, sponsored repo activity, in which dealer-banks net two sides of a trade and hold less capital against it, and Triparty General Collateral Rate volumes rose $54 billion and $10 billion, respectively, from July 30 through Aug. 8, according to Citi. During that same period RRP usage declined by $64 billion, which suggests that additional counterparty channels were put in place for some of the larger money-market funds, “allowing them to reallocate some of their remaining RRP cash,” Williams said.
That’s because sponsored repo transactions allow lenders to transact with counterparties like money-market funds and hedge funds, without facing regulatory constraints from their own balance sheets. These agreements are effectively “sponsored” or cleared via the Fixed Income Clearing Corp.’s repo platform, thereby allowing dealer-banks to net two sides of a trade and hold less capital against it.
Yet, there’s a debate among Wall Street strategists as to whether FICC constraints are partially responsible for flatlined RRP. Bank of America Corp. strategists have surmised that capacity is capped by the number of dealer sponsors, margin requirements into the firm and money funds’ internal limits on exposure to the counterparty, though Barclays Plc said the capacity issues are unlikely.
Citi’s Williams thinks it will be worked out over time “but its a slow process” and could not specify a timeframe.
Meanwhile, it’s unclear whether repo rates will stay at current levels going forward. Treasury bill supply is expected to build up into the end of August, which should pull money-market rates higher and draw more cash out of RRP.
“We struggle to see why repo rates will remain materially subdued from here,” Williams said.
©2024 Bloomberg L.P.
