Effective January 13, 2014
What is a Fed reverse repurchase agreement?
The Open Market Trading Desk (the Desk) at the Federal Reserve Bank of New York (New York Fed) is responsible for conducting open market operations under the authorization and direction of the Federal Open Market Committee (FOMC). A reverse repurchase agreement, also called a “reverse repo” or “RRP”, is an open market operation in which the Desk sells a security to an eligible RRP counterparty with an agreement to repurchase that same security at a specified price at a specific time in the future. Thus, the Desk receives cash from the counterparty and then returns cash at the specified time in the future. The difference between the sale price and the repurchase price, together with the length of time between the sale and purchase, implies a rate of interest paid by the Federal Reserve on the cash invested by the RRP counterparty.
When the Desk conducts an overnight RRP, it is selling an asset held in the System Open Market Account (SOMA) with an agreement to buy it back on the next business day. This leaves the SOMA portfolio the same size, but shifts a liability on the Federal Reserve’s balance sheet from “deposits” to a reverse repo while the trade is outstanding.
A “repo,” or “RP,” is the opposite transaction, where the Fed purchases a security from a counterparty with an agreement to sell it back at a later date for a specific price. Thus, in this case the Desk lends funds to the primary dealers. A repo creates both an asset on the Fed’s balance sheet (the repo) and increases the "deposits" liability.
Why is the Fed interested in overnight, fixed-rate full allotment RRPs?
The minutes from the July 2013 meeting of the FOMC reported that the Desk briefed the FOMC on the potential for a fixed-rate, full-allotment overnight reverse repo (ON RRP) facility, and suggested that such a facility could improve the Committee’s ability to manage short-term interest rates, regardless of the size of the Federal Reserve’s balance sheet.
At the September 2013 FOMC meeting, the FOMC authorized the Desk to conduct a technical exercise to gain operational experience with larger transactional flows and, consistent with the discussion at the July meeting, provide additional information about how such operations might improve the Committee’s ability to manage short-term interest rates, regardless of the size of the Federal Reserve’s balance sheet. The exercise is part of an ongoing effort to improve the technical execution of policy. By conducting daily operations that are somewhat larger than the Desk’s previous small-value RRP exercises over a period of weeks, these operations will help the Desk, the tri-party clearing banks, and the Federal Reserve’s counterparties better understand how ON RRPs could work and provide experience with somewhat larger transaction volumes.
Does this represent a change in the stance of monetary policy?
Like earlier operational readiness exercises, these operations are a matter of prudent advance planning by the Federal Reserve. They do not represent a change in the stance of monetary policy, and no inference should be drawn about the timing of any future change in the stance of monetary policy.
How can an ON RRP facility help provide the Federal Reserve with greater control over short-term interest rates?
In many ways, an ON RRP facility would operate similar to the way the Federal Reserve’s payment of interest on excess reserves works for depository institutions. Absent other constraints, any counterparty that is eligible to participate in the ON RRP facility should generally be unwilling to invest funds overnight with another counterparty at a rate below the facility rate. The effectiveness of the facility will depend on a range of factors, including whether a sufficiently broad set of counterparties has access to the facility, the costs associated with regulatory and balance sheet constraints, and the level of competition in the money markets.
How does an ON RRP facility complement the Federal Reserve’s existing tools?
Efforts over the last several years have focused on developing the kinds of tools that will be needed to influence short-term interest rates in the future. Those tools include open market operations like term RRPs and asset sales, as well as the Term Deposit Facility (TDF), which were designed to drain excess reserve balances, and thus influence interest rates by reducing the supply of reserves. Initial efforts focused first and foremost on ensuring the necessary operational infrastructure was in place to support those operations. More recently, work has focused on alternative ways to use the existing tools. In this case, an ON RRP facility could be used more directly to help manage short-term interest rates.
How are these operations different from the small-value RRPs the Desk has been conducting?
The Federal Reserve has been conducting operational exercises involving term RRPs since late 2009. Those exercises have been fixed-quantity auctions where RRP counterparties bid both a rate and an amount, with the total amount outstanding limited to $5 billion or less. This new exercise is an extension of these periodic operational exercises, but changes the auction to a fixed-rate format, where the Federal Reserve fixes the interest rate within limits established by the FOMC, and participants express their interest by indicating the amount of RRPs they would like at that rate. Within this format, the constraint on the aggregate size of the operation is limited by a per-counterparty bid. This will allow the Desk to conduct daily overnight capped-allotment RRPs, which are closely related to the fixed-rate, full-allotment structure discussed in the July 2013 FOMC minutes.
Who is eligible to participate in the operations?
Participation in the operations is open to all of the Federal Reserve’s RRP counterparties. The Federal Reserve currently has 139 RRP counterparties, covering a wide range of entities—94 of the largest 2a-7 money market funds, six government-sponsored enterprises (Fannie Mae, Freddie Mac, and four Federal Home Loan Banks), 18 banks, and the 21 primary dealers. Additional details on the RRP counterparties are available on the New York Fed’s website.
Are the operations expected to impact funding markets?
The operations are technical exercises that are not intended to have a material impact on short-term interest rates. The individual counterparty bid limits as well as the low fixed rate should minimize any impact.
How will the rate and allotment limit change for the operations?
As noted in the statement, the initial fixed rate for the RRP operations will be set at 0.01 percent (one basis point) and the initial allotment cap will be set at $500 million per counterparty per day. The rate and allotment limit are subject to change at each operation, but are likely to remain fixed for some time to replicate features of a permanent facility. Adjustments to the rate will generally be made in cases where usage in the exercise is relatively low. The counterparty allotment limit may be increased if participation in the operations shows that many counterparties are subscribing to the operations at their maximum allotment limit. Such changes would only be implemented if they are not expected to materially influence funding market conditions. Any change to the operational parameters will be announced on the New York Fed’s public website at least one business day prior to an operation, so that all parameters are known to all market participants before each day’s trading session.
What collateral will be used for these operations?
The RRPs during this operational exercise are expected to be collateralized by Treasury securities. SOMA’s holdings of agency debentures and agency mortgage-backed securities are available for use, but are not expected to be used in this exercise.
At what time of day will operations be conducted?
As noted in the January 13, 2014 statement, RRP operation time changed to 12:45 p.m. to 1:15 pm. (Eastern Time), effective January 15, 2014. The RRPs in this exercise were initially conducted by the Desk from 11:15 a.m. to 11:45 a.m. (Eastern Time). RRP operation times can still be moved earlier or later in the day. Any change to the timing of the operation will be communicated at least one business day in advance.
How long with this operational exercise last?
As noted in the statement, operations will begin on Monday, September 23, and the Desk has the authority to conduct these overnight operations through January 29, 2014. The Desk will conduct the operations for an initial period of several weeks and then publicly announce whether the exercise will be continued or terminated.