US Fed reverse repo facility balances sink below $100 billion from record high after lowering RRP by 30 bps to 4.25%

US Fed reverse repo rate: Investors' deposits at the US Federal Reserve facility dropped below $100 billion for the first time since 2021 after US Fed policymakers adjusted the parameters this week. According to Bloomberg, 40 participants put a combined $98.4 billion at the US Fed’s overnight reverse repurchase agreement facility, used by banks, government-sponsored enterprises, and money-market mutual funds to earn interest. 

According to New York Fed data, it marks a steep decline from a record $2.55 trillion stashed on December 30, 2022. The latest decline in usage comes after US Fed officials lowered the rate on the reverse repurchase agreement (RRP) relative to the lower bound of the policy target range by five basis points on Wednesday, aiming to keep US funding markets running smoothly.

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US Fed slashes reverse repo rate in December

Taken together with the US Fed’s reduction in the overall target range for the fed funds rate to 4.25 per cent to 4.50 per cent, the new RRP rate is 4.25 per cent — in line with the lower bound for the first time since 2021. The facility is designed to help put a floor under the US Fed’s target for the federal funds rate by soaking up cash from outside the banking system. 

The move may aim to preempt tightness in money market rates. It may also allow the US Fed to shrink its balance sheet by driving more money into bank reserves. The US Fed also announced it would reduce the rate it pays lenders using its overnight reverse repurchase facility by 30 basis points.

While balances at the facility, a barometer of excess liquidity in the financial system, have dropped by $2.4 trillion since their December 2022 peak, the pace of declines has slowed in recent months. On Wall Street, the sum of cash parked at the RRP has long been considered a useful gauge to watch as the US Fed unwinds its balance sheet via quantitative tightening.

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The downshift was foreshadowed in the minutes of the US Fed’s November meeting, in which policymakers revealed they saw value in a potential “technical adjustment” so the RRP rate would equal the bottom of the target range for the federal funds rate. Market watchers have said the move will likely exert downward pressure on money market rates and impact funds held at the US Fed facility. 

Since the adjustment on Wednesday, Treasury bills have yielded more than the RRP, which may be spurring the shift away from the central bank. However, that could change as T-bill settlements will remove about $70 billion of supply from the market, driving rates lower and money back into the daily operation. 

The last time the US Fed tweaked the rate on the RRP facility was in June 2021, when a dollar glut in short-term funding markets outstripped the supply of investable securities and weighed down front-end rates despite the steadiness of the US Fed’s key benchmark. At the time, $521 billion in cash was squirrelled away at the overnight RRP facility.

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US Fed December policy verdict

US Fed now projects just two quarter-percentage-point rate reductions by the end of 2025, down from their September estimate of four rate cuts. “In considering the extent and timing of additional adjustments to the target range, the Committee will carefully assess incoming data, the evolving outlook, and the balance of risks,” said the central bank in its statement.

The US Fed adjusted a key part of its rate control toolkit, lowering the rate it offers on its reverse repo facility by more than it cut the federal funds rate. The US Fed said that the reverse repo rate will now stand at 4.25 per cent from its prior level of 4.55 per cent, marking a 30 basis point easing. It also lowered the federal funds target rate range for the third straight time to 4.25 and 4.5 per cent.