Why The Fed Is Reducing Repo Operations

At a Glance

  • The Federal Reserve will reduce overnight repurchase agreement operations from $120 billion to $100 billion
  • April marks a key moment for continued operations with personal tax payments due

The U.S. Federal Reserve plans to gradually reduce its “repo operations” over the next few months in response to calmer prevailing market conditions. The cash infusions have been the major supplier of liquidity to the U.S. repo markets.

The Fed announced in mid-February that it would reduce the size of its term operations by $5 billion to $25 billion by the end of February, and by $5 billion to $20 billion from March onwards before potentially winding down the current program altogether.

“The Desk would continue the gradual reduction and consolidation of its repo offerings ahead of April with the plan of phasing out term repo operations after April.” the Fed reported in the official minutes of its January meeting.

Strong Response

The Fed introduced significant repo operations in the wake of the repo funding issues experienced in September and has since become the major supplier of liquidity to the U.S. repo markets, limiting the impact on the U.S. repo market of external factors like the coronavirus.

The additional liquidity in the system had also helped to ensure that the traditionally volatile end-of-year funding period passed off without incident, and the Fed now intends to slowly withdraw its additional liquidity without adversely affecting the U.S. repo market.

At the same time the Fed’s overnight operations will be reduced to $100 billion from $120 billion, although this is unlikely to have a significant impact on the market as the size of the overnight facility far surpasses the market’s current liquidity needs.

The Fed also announced that it would consider gradually raising its minimum bid for overnight repo over the next few months.  The authorities have typically been providing liquidity at a slightly cheaper level than prevailing commercial rates, leading some repo market observers to dub the Fed “the buyer of first resort.”

All Eyes on April

It will take some months for the Fed’s planned reduction in liquidity provision to have a significant impact on the market.  The program of reductions is deliberately gradual to enable the U.S. repo market to slowly wean itself off the Fed’s provision of liquidity at relatively inexpensive levels.

The Fed is also highly aware that September’s repo crunch was in part attributed to the influx of corporate taxation receipts into the Treasury General Account (TGA), which drew cash out of the U.S. financial system.  April is the month for personal tax payments in the U.S., again raising the specter of a cash crunch that could negatively impact the currently subdued volatility in U.S. repo rates.

No one wants to see a repeat of the issues the repo market briefly faced last September, particularly not the Fed.  And particularly when there are also concerns about a potential scarcity of Treasury bills in the second quarter of 2020, as a result of ongoing T-Bill purchases and maturing supply.

If April passes off peacefully, the Fed is likely to step up its withdrawal from repo operations, as it has already previewed.  But few market participants are expecting much change to the current status quo before the tax season has passed off peacefully.

is Global Head of Research at CME Group. He is based in London.

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