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$5 Trillion Money Market ‘Bubble’ Spotlights Fed’s $2 Trillion RRP Garage
Last week, I suggested the Fed is attempting a difficult tightrope act with regard to deposit outflows and the desirability of engineering tighter credit conditions in the service of fighting inflation.
In "Deposit Flight And More Fed Hubris," I sketched the contours of what some might describe as an absurd situation. A Fed facility is contributing to instability in the banking sector, and that instability last month prompted the Fed to create a new facility to prevent the problem from becoming
Isn’t there some arbitrage-type linkage between Fed Funds, repo rate, SOFR, and reverse repo rate, such that those rates all have to be relatively close to each other? Not a rhetorical question.
Didn’t find an answer on the arb question, but anyway I am not seeing an easy way to reduce the RRP size, so long as the Federal is actively hiking and MMFs don’t have enough other places to put money.
https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements “The Overnight Reverse Repo Facility (ON RRP) helps provide a floor under overnight interest rates by acting as an alternative investment for a broad base of money market investors when rates fall below the interest on reserve balances (IORB) rate.”
The rate for Interest on Reserve Balances (IORB) and sometimes the Standing Repo Facility (SRF) set the upper bound for overnight rates.
For how the Federal Reserve moved from setting rates via open market operations to setting rates via IORB and RRP, see https://www.stlouisfed.org/open-vault/2020/august/how-does-fed-influence-interest-rates-using-new-tools
Does a government debt default (or the threat thereof) pose a risk to this “bubble”? I’m not totally comprehending how protected these funds are if the feds fumble. Same question regarding directly purchased treasuries.
Simpler would be better….