The Reverse Repo facility balance grew to $1.9 trillion to then slowly decrease to $1.64 Trillion over the past few months. Although the Reverse Repo facility allows the Federal Reserve, to access the open market by selling Treasuries to then repurchase those securities the following business day, this open market operation tool could not be entirely what it seems.
In effect, there are other data to consider in order to try in gathering an understanding of financial flows in money markets between Central Bank and primary dealers. As in fact, the Overnight Bank funding rate has increased to $241 billion dollars, that regards the wholesale unsecured overnight bank funding tapped into the Federal Reserve, in other words for that regard unsecured borrowing describes how higher the risk of default becomes with: banks, hedge funds and corporations that do not post any securitized collateral in order to access Federal Reserve credit. Also, the Secured Overnight Financing has been averaging $960 billion dollars for some months, thereby indicating that the U.S. Financial system has a daily shortfall of $1201 billion in between business days, otherwise a mismatch of assets and liabilities between banks and funds in the financial system that requires the tapping of $960 into the Secured Overnight Financing from the Federal Reserve, thereby signalling a financial system where Treasuries stocks and flows, assets and liabilities are in disequilibrium. The question of such a large amount transacted daily with the Reverse Repo facility, $1.648 Trillion dollars, does arise questions about the stability of the U.S. dollar money market stability and with that of funds and banks correlated to the money markets. In fact, the Repo facility, allows hedge funds, investment funds, broker-dealers, banks to sell their Treasuries in exchange for USDollar liquidity, with overnight financing transactions, to then see hedge funds, investment funds, banks to Repurchase the Treasuries posted as collateral with the Federal Reserve the following business day, except for REPO, Repurchase transactions that are continuous. Therefore, the U.S. dollar money market is in effect liquid, however, this liquidity has been leveraged, sometimes highly leveraged. The collateral effects on the financial system are that Hedge Funds, Investment funds, broker-dealers and similar do utilize the REPO facility to finance their balance sheet, in practice by leveraging Treasuries, sold as collateral to the Federal Reserve, with a continuous REPO transaction , to then access liquidity that can be in hundreds of millions often in billions of dollars. Thereby, the hedge fund and investment funds industry works by leveraging their balance sheet through the REPO facility, to then place bets in the stock market, this mechanism can easily break up because of leverage and the exposure of hedge funds to the broader financial assets classes such as: stocks, corporate debt, corporate loans, financial derivatives, that increases the investment risk profile of hedge funds, investment funds and banks, without raising red flags because the nature of the funding has been collateralized with U.S. Treasuries debt.
Therefore hedge funds could be likely to require unsecured overnight financing, other volatility risks could entail Treasuries sell-offs and U.S. Dollar debt sell-offs, such as municipal bonds sell-offs, at the same time that stocks and the equity market also deleverage, while the acute stress scenario could become a USDollar money market freezing.
In this case, we can observe and we have seen already the collateral effects of the Treasuries leveraged trade, as the Federal Reserve holds for months Billions of collateralized Treasuries in REPO transactions, it becomes then forced to activate the Reverse REPO facility tool, in order to balance the mismatches in borrowing required through the Overnight Bank Funding facility and the Secured Overnight Financing, meanwhile also the Federal Reserve has to balance the U.S. Treasury account, therefore making sure that the U.S. Treasury has sufficient daily USDollar liquidity to deal with the outstanding stock of Treasuries floating in the markets.
Overnight Bank Funding Rate (OBFR)2/17/2022