On the importance of the Fed’s reverse repo facility for safe asset collateral

By Sober Look

Expectations of future shortages in quality liquid bonds in US debt markets continue to persist (see story). These shortages however are likely to be more acute for short-term paper. As a percentage of total government debt for example, treasury bills outstanding continue to decline.

Source; Barclays Research

Similarly, commercial paper volumes remain subdued relative to historical levels, as banks and corporations no longer want to rely on money-markets-based funding to finance their operations.

At the same time the US broad money supply has almost doubled in the past 10 years. Savers are looking for more relatively safe short-term product that can compete with bank deposits. That is why the Fed’s reverse repo facility (FRFA – see post) is going to be so critical in the next few years. The Fed now holds nearly $4 trillion in securities, which the central bank can “sterilize” by taking in short-term deposits. These deposits in turn will be a good alternative to treasury bills and bank deposits, providing some relief to product-starved US money markets.