Banks could cut lending in rate / fx swaps as reverse repurchase agreements grow -Credit Suisse analyst

ByRichard C. Sloan

Jul 7, 2021

By Karen Brettell

July 7 (Reuters) – U.S. banks and money markets are likely to invest more in the Federal Reserve’s repo facility in the coming months, which could reduce bank deposits and therefore lending in the money and bond markets , creating disruption in the markets, according to Zoltan Pozsar, analyst at Credit Suisse.

Money market funds are borrowing record amounts of Treasuries from the Fed as part of its reverse repo facility since the Fed last month raised the rate it pays on loans to 5 basis points, instead of zero.

In the facility, investors provide the Fed with overnight loans that are backed by Treasury bills.

Demand has also increased as the Treasury cuts its bond issuance to lower its cash level ahead of a two-year suspension of the federal debt ceiling expiration at the end of this month.

As MMFs invest more in reverse repo, they can leave banks less deposits, either by pulling their money out to make the investments or by abandoning treasury bills and letting other investors in turn withdraw. deposits to invest in bonds.

Money market funds are more likely to turn to reverse repo transactions if bond yields are trading below 5 basis points, which would make the repo facility relatively more attractive, Pozsar said in a report released on Wednesday. .

Meanwhile, banks will likely invest more in reverse repo as they continue to build up reserves by selling bonds to the Fed and as treasury bill issuance declines.

Pozsar said repo demand is expected to exceed $ 1.3 trillion by September, compared to around $ 800 billion today.

If this increase occurs and bank reserves fall to $ 3.5 trillion, it will indicate that banks have fewer deposits to lend in the foreign exchange swap market and in longer-term treasury bills and securities. mortgage backed.

This could leave lending gaps in these markets which could create market imbalances.

“We are looking at moving from one marginal lender / buyer to another – a transition that should be smooth, but maybe not,” said Pozsar.

Banks had $ 3.87 trillion in excess reserves in April, according to data from the Fed. (Reporting by Karen Brettell in New York; Editing by Alden Bentley and David Gregorio)