Overnight Reverse Repo: Softening Demand?

By Stone Jiang, FRM

Despite the significant growth in 2021 and 2022, we anticipate a decline in take-up of the Fed facility in the coming months.

The Federal Reserve’s Overnight Reverse Repo (ON RRP) facility enables eligible institutions to lend excess money to the Fed while earning a predetermined rate. ON RRP take-up is often considered to be part of the excess liquidity in the financial system. Over a couple of years, we saw rapid growth in the use of the facility, but we think that demand is likely to decline from here.

Key Drivers for the Demand Surge

ON RRP take-up saw significant growth starting in 2021, rising from nearly zero to over $2 trillion by the end of 2022. A key reason was demand from money market funds (MMFs) – the primary investors in ON RRP – which grew their assets by 1.2 trillion from late 2019 to late 2022. During this period, ON RRP gained favor among MMFs compared to competing assets such as Treasury bills and private repos. As the outstanding amount of Treasury bills decreased by approximately $1.2 trillion in 2021, the available investment options for MMFs narrowed. During the same period, the spread between the Secured Overnight Financing Rate (SOFR), a proxy for the overnight private repo rate, and the ON RRP rate narrowed to around zero, making ON RRP more appealing. As a result, MMFs shifted more than 30% of their allocations from short Treasury securities and private repos to ON RRP, as indicated by Form N-MFP reports.

Anticipating a Decline in Demand

While MMF assets might still grow due to their higher yields compared to deposit rates, competing assets are likely to gain the upper hand. First, the resolution of the debt ceiling issue would lead to the resumption of bill issuances by the U.S. Treasury. Second, the SOFR/ON RRP spread, which dipped below 0 in 2022, has started to turn positive in 2023, increasing the allure of private repos. Notably, from December 2022 to May 2023, MMF assets grew by $593 billion, while ON RRP take-up decreased by $60 billion.

Final Thoughts

Despite significant growth in 2021 and 2022, we anticipate a decline in ON RRP take-up in the coming months. Factors such as the potential increase in bills outstanding and the attractiveness of private repos are likely to drive this shift. In our view, the anticipated decline would also offer valuable insights into the ongoing tightening of the financial system.

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