Fed reverse repo transactions… Temporary open market operations include short-term repurchase and reverse repurchase agreements designed to temporarily add or drain existing reserves to the banking system and affect day-to-day operations in the federal funds market. A reverse repo contract (known as a reverse repo or RRP) is a transaction in which the New York Fed, under the authority and direction of the Federal Open Market Committee, sells a security to an eligible counterparty under an agreement to repurchase the same security at a specified price. Securities eligible for these transactions are US Treasury vehicles, federal agency debt, and mortgage-backed securities issued or fully guaranteed by federal agencies.
Federal Reserve reverse repo transactions 20/04/22… Source: Federal Reserve Bank of New York
Why does the Fed use reverse repo? A reverse repo is a short-term agreement to buy securities to sell them back at a slightly higher price. Repos and reverse repos are used for short-term borrowing and lending, often overnight. Central banks use reverse repo to add money to the money supply through open market operations.
A high repo rate helps drain excess liquidity from the market, while a high reverse repo rate helps inject liquidity into the economic system. The repo rate is always higher than the reverse repo rate. The repo rate is used to control inflation and the reverse repo rate is used to control the money supply. An increase in the reverse repo rate will decrease the money supply and vice versa, other things remaining constant.
Reverse repo graph… Source: Federal Reserve Bank of New York
Conclusion? The New York Fed conducts repo and reverse repo transactions every day to help keep the federal funds rate within the target range set by the Federal Open Market Committee (FOMC). In a macro example of RRPs, the Fed uses repos and RRPs to stabilize lending markets through open market operations (OMO). The RRP transaction is less used by the Fed than a repo because when a repo is short it puts money into the banking system, while an RRP borrows money from the system when there is too much liquidity. The Fed runs RRPs to maintain long-term monetary policy and ensure capital liquidity levels in the market.
A steady rise in reverse repos this year tells the Fed that banks no longer need help and could curb liquidity addition measures, originally designed as a short-term response to a crisis, without any intervention. The massive increase in reverse repo volume means that the financial system is now self-supporting after a lot of help from the Fed.
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