The new & improved SRF begins to serve its purpose of allowing the Fed to push QT as far as possible without blowing anything up, unlike last time.
That banks are starting to use the Fed’s Standing Repo Facility (SRF) occasionally and with relatively small amounts has in recent days been twisted into headlines about banks facing a funding crisis and running out of cash or whatever.
A primary purpose of the SRF is for banks to step into the repo market when repo market rates rise enough above the Fed’s policy rate for repos, 4.25% since the rate cut. Banks borrow at the SRF’s policy rate of 4.25%, and lend those amounts to the repo market at the higher rates in the market, and make money on the spread. This douses the brushfires in the repo market before they get big.
Last week, the Secured Overnight Funding Rate (SOFR), which tracks a $3-trillion-a-day segment of the repo market, had risen intraday as high as 4.39% on Wednesday and 4.41% on Thursday, with the average SOFR at 4.29% and 4.30% on those days, and some banks jumped in, borrowed at 4.25% at the SRF and lent overnight to the repo market at the higher rates that they could get there, and made some easy risk-free profits.
It had the desired effect. By Friday, the majority of the trades were below 4.20%, and the average SOFR was 4.18%, and the banks did not borrow from the SRF on Friday to lend to the repo market, and the SRF balance reverted to zero.
Today, repo trading is still going on, and the SOFR rates haven’t been released yet.
Repo market rates fluctuate quite a bit now that the Fed’s QT has wrung $2.4 trillion in excess liquidity out of the market. And the SRF activity when banks stepped into the repo market matches the high points of SOFR. The chart shows the final repo rates for each day, as released by the New York Fed, not the intraday highs:
The repos at the SRF are overnight repos that mature the next business day, when banks pay back to the SRF the amount they borrowed and get their collateral back. They don’t stick on the Fed’s balance sheet for years or decades, unlike QE bonds. Which is why the balance of the SRF goes to zero on days when it is not used. Which is exactly what happened on Friday.
On Wednesday and Thursday last week, repo rates had risen to the point that it was profitable for banks to borrow at the SRF at 4.25% and lend to the repo markets at higher rates and make money on the spread, and this lending to the repo market helped repo market rates to calm down. On Wednesday, the uptake at the SRF was $6.75 billion and Thursday $8.35 billion.
On Friday, the balance was back to zero and there was no activity at the SRF.
At the auction this morning (Oct 20), there was no activity. At the auction this afternoon, $2 billion were drawn and the total balance today ended at $2 billion:
The purpose of the SRF is to prevent repo market rates from blowing out again, as they had done in September 2019, which had caused the Fed to step directly into the repo market, undoing a big part of the QT it had done over the prior two years. And it learned a big lesson.
In July 2021, in preparation for withdrawing liquidity through QT, the Fed re-established its Standing Repo Facility that it had shut down in 2009, and that it then didn’t have in September 2019.
The banks are using the SRF exactly how the Fed has long exhorted banks to use it: to keep a lid on the interest rates in the vast repo market. If the SRF had been in place in the fall of 2019, the few brushfires would have been doused before they exploded into a firestorm.
The Fed has improved the SRF this year, including by adding a morning auction, so now there is a morning auction and an afternoon auction to match the daily liquidity flows of the markets.
The new and improved SRF has now begun to serve its purpose of allowing the Fed to push QT as far as possible without blowing anything up. And it has been praised as such in Fed communications.
In the days before 2009, before the Fed inflated its balance sheet with QE, the SRF was constantly in use, and when a market problem arose, such as in the days following September 11, 2001, as markets were shut down because some of the infrastructure for electronic trading had been destroyed, banks used the SRF to provide liquidity to the markets, and within two weeks, as liquidity flows had normalized, the repo balance was back to normal, no QE needed:
