The RRP facility served as a parking spot for excess corporate savings after COVID. Its usage flatlining is not a technical liquidity signal but an economic one: corporations have spent their cash reserves and are now under financial stress, which validates the broader fiscal tightening thesis.
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Official liquidity measures like Fed balance sheet levels are too slow to be tradable. A better approach is to monitor the symptoms of liquidity conditions in real-time market data. Indicators like SOFR spreads, commercial paper spreads, and unusual yield curve shapes reveal the health of private credit creation.
The recent uptick in the Fed funds rate was not a direct signal of scarce bank reserves. Instead, it was driven by its primary lenders, Federal Home Loan Banks, shifting their cash to the higher-yielding repo market. This supply-side shift forced borrowers in the Fed funds market to pay more.
The Fed's SRF is proving ineffective at capping repo rates. Despite rates trading well above the facility's level, usage was minimal. This indicates a market stigma or hesitation, questioning its ability to function as a reliable backstop for temporary liquidity shortages and control rates.
The common narrative of the Federal Reserve implementing Quantitative Tightening (QT) is misleading. The US has actually been injecting liquidity through less obvious channels. The real tightening may only be starting now as these methods are exhausted, signaling a significant, under-the-radar policy shift.
The impending halt of the Fed's balance sheet reduction (QT) is not a reaction to a major economic crisis, but a technical necessity to prevent stress in short-term funding markets as bank reserves become scarce. The Fed is preemptively avoiding a 2019-style repo spike, signaling a quiet return to mild balance sheet expansion.
Unlike September 2019, the recent corporate tax day saw no funding crisis. The mere existence of the Fed's Standing Repo Facility (SRF) calmed markets, preventing panic. This psychological backstop, combined with higher bank reserves and a better regulatory environment, proved crucial for stability.
Recent spikes in repo rates show funding markets are now highly sensitive to new collateral. The dwindling overnight Reverse Repo (RRP) facility, once a key buffer, is no longer absorbing shocks, indicating liquidity has tightened significantly and Quantitative Tightening (QT) has reached its practical limit.
Over the past few years, the Treasury Department and the Federal Reserve have been working at cross-purposes. While the Fed attempted to remove liquidity from the system via quantitative tightening, the Treasury effectively reinjected it by drawing down its reverse repo facility and focusing issuance on T-bills.
If the Fed adopts a repo rate like TGCR as its policy benchmark, its Standing Repo Facility (SRF) must evolve. It would shift from being a passive emergency backstop to an active tool for daily rate management, similar to how the Fed's RRP and IORB rates currently operate.
Enormous government borrowing is absorbing so much capital that it's crowding out corporate debt issuance, particularly for smaller businesses. This lack of new corporate supply leads to ironically tight credit spreads for large borrowers. This dynamic mirrors the intense concentration seen in public equity markets.
