QT has only drained ON RRPs so far, but not Reserves, which are still where they’d been when QT started in July 2022. QT has a long way to go.

By Wolf Richter for WOLF STREET.

Balances at the Fed’s facility for Overnight Reverse Repurchase agreements (ON RRPs) fell to $98 billion on Friday, the lowest since April 2021, down from $2.4 trillion from the peak at the end of December 2022, and well on their way to zero or near-zero, where they were in normal times, and where the Fed wants them to be again.

To help them get to zero more quickly, the Fed lowered its ON RRP offering rate – one of its five policy rates – on Wednesday by 5 basis points, in addition to the 25-basis-point cut that all its five policy rates got. At 4.25%, the offering rate is now even with the bottom of the Fed’s target range for the federal funds rate. The minutes of the November meeting already revealed a discussion to that effect, and so this was not a surprise.

The purpose of this reduction in the ON RRP offering rate was to encourage money market funds (MMFs) to pull their cash out of this facility that the Fed provides and find other places for their cash where they can earn a little more interest, such as regular repos or T-bills (4.30%-plus), which currently yield more than the reduced ON RRP offering rate (4.25%).

MMFs are the primary users of the ON RRP facility at the Fed. The ON RRP balances represent excess liquidity that the Fed created during QE that financial markets don’t know what else to do with, so they stash it at the Fed.

As part of its QT, the Fed has now drained $2.1 trillion in liquidity from the markets, and essentially all of the drainage has come out of ON RRPs, instead of the reserves.

Reserves represent cash that banks deposit at the Fed to settle transactions and to collect interest on the balances. Interest on reserves (IOR) is one of the Fed’s five policy rates, currently 4.40%.

QT is supposed to whittle reserves down from “abundant” to merely “ample,” but the Fed doesn’t know where “ample” is, except it’s quite a bit lower, and the Fed is trying to get reserve balances there carefully.

But QT has so far only drained ON RRPs, while reserves, currently at $3.28 trillion, are still where they had been when the Fed started QT in the summer of 2022. As far as reserves are concerned, QT hasn’t even started yet, and there is still quite a ways to go before they get to “ample.”

The ON RRP offering rate is usually at the bottom of the target range for the federal funds rate, and at this rate, and under normal conditions, ON RRP balances are generally zero or close to zero, as we can see in the first chart above.

The Fed had raised the ON RRP rate by 5 basis points off the bottom of its target range on June 17, 2021. At the time, its target range for the federal funds rate was 0.0% to 0.25%, and it raised the offering rate from 0% to 0.05%. And until Wednesday, it remained 5 basis points above the bottom of the target range.

 

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