By Michael S. Derby
NEW YORK (Reuters) – An important tool the Federal Reserve uses to help keep short-term interest rates under control rose on Friday (the U.S. Federal Reserve’s last trading day). A record inflow of money was recorded that year.
The New York Fed said its reverse repurchase facility had absorbed $2.554 trillion in cash from money market funds and other eligible financial firms, more than The previous high was in September 28, when inflows totaled $2.33 trillion.
The cash surge is almost certain to enter record territory in the typical end-of-quarter pattern, a pattern that could intensify further into the end of the year. In those days, many financial firms preferred to park their cash with central banks rather than private markets for a variety of reasons.
The Fed’s reverse repurchase facility has been very active for some time. After seeing little uptake for a long time, cash started flowing to central banks in the spring of 2021 and then continued to grow. Daily reverse repo usage has remained above $2 trillion since June.
The reverse repo facility takes cash from eligible financial firms, which are effectively Fed loans. The current interest rate is 4.3%, a rate of return that is typically better than short-term lending rates in the private sector.
The reverse repurchase facility is designed to provide a soft floor on short-term interest rates and the federal funds target rate, the Fed’s primary tool for achieving its job and inflation goals. To set the upper end of the range, the Fed also pays deposit-taking banks to park cash with the central bank, where the interest rate on reserve balances currently stands at 4.4%.
The fed funds rate is currently set between 4.18% and 4.5%, trading at 4.554% As of Friday, subject to the reverse repo rate and interest on reserve balances.
No sign of contraction
Fed officials have been unfazed by large inflows, even with heavy use of reverse repos, even as some in financial markets have worried the Fed could run out The outlook for private money market lending activity.
Fed officials also expect that use of the reverse repurchase facility should decrease as the central bank raises rates to reduce sky-high inflation. But that hasn’t happened yet, and some in the market now believe that continued high usage of the Fed’s tools will continue for some time.
Research from the New York Fed shows that bank regulatory issues have led to high demand for the Fed’s reverse repurchase facility. Meanwhile, the Kanas City Fed added that the large capital inflows are related to limited private market investment opportunities and policy uncertainty.
The flood of cash flowing into central banks may not alarm central bankers, but has pushed their businesses into de facto losses. The Fed finances itself through the interest on the bonds it holds and the services it provides to the financial world. Usually it makes a handsome profit, which is handed back to the Treasury by law.
Currently, the cost of paying interest on reverse repos and reserve balances exceeds revenue. The Fed reported on Thursday that the accounting measure it uses to track losses was 28 billion as of December 28. Many observers expect the Fed’s plan to raise rates further and keep them high means that the central bank will suffer considerable losses over time, even if those losses do not affect the central bank’s monetary policy work.