Quiver Quantitative - This week marked a significant uptick in the use of the Federal Reserve's Standing Repo Facility (SRF), with demand reaching its highest level since July 2020. The SRF, a mechanism where banks can exchange Treasury and agency debt for reserves at a rate of 5.50%, saw counterparties withdraw $203 million on December 5. This surge in activity comes as the financial markets experience heightened volatility, particularly after the Secured Overnight Financing Rate (SOFR) escalated to a record 5.39% on December 1.
The increased utilization of the SRF, though still modest compared to the $153 billion peak in March 2020, is a notable development given the ongoing balance sheet contraction by the Federal Reserve. The reduction in excess liquidity and the recent spike in funding costs, exacerbated by dealer balance sheets' incapacity to provide adequate funding, have put market participants on high alert for potential disruptions. The recent events have led some banks to test the SRF's capabilities, as indicated by Deutsche Bank (DB) strategist Steven Zeng, who noted that a specific bank had recently set up for the SRF.
As the Federal Reserve continues its balance sheet normalization, the SRF stands as a crucial mechanism for maintaining stability in the repo markets.
Market Overview:
The Federal Reserve's Standing Repo Facility (SRF) witnessed its highest usage since 2020 this week, with counterparties tapping the facility for $203 million on December 5th. This surge in demand coincides with recent volatility in the funding markets, marked by a sharp rise in the Secured Overnight Financing Rate (SOFR) to a record high of 5.39%.
Key Points
-The SRF allows eligible banks to borrow reserves at 5.50% in exchange for Treasury and agency debt, acting as a liquidity backstop in times of market stress. -Demand for the SRF peaked at $153 billion in March 2020 during the pandemic but has remained relatively low since then. -The recent spike in usage is attributed to market participants testing the facility's functionality as the Fed continues to unwind its balance sheet and liquidity dwindles. -Increased government borrowing and limited capacity of dealer balance sheets contributed to higher funding costs and the SOFR jump, raising concerns about potential market disruptions.
Looking Ahead:
While demand dropped back to $6 million on Wednesday, market observers are closely watching the SRF for any signs of instability. The addition of five new counterparties to the SRF in the past two months suggests increased interest in this backstop facility. The SRF's effectiveness remains under scrutiny, with some questioning its accessibility to only a limited number of institutions.
This article was originally published on Quiver Quantitative