We hesitated to cover the first articles saying the Federal Reserve was looking into doing reverse repurchase agreements (repos) with money market mutual funds due to the lack of official comment and details. But now that several publications have commented, we feel obligated to mention these. As Reuters summarized in its "Fed's exit strategy may use money market funds: report," "The U.S. Federal Reserve is studying the idea of borrowing from money market mutual funds as part of eventual steps to withdraw stimulus, the Financial Times reported on Thursday. The Fed would borrow from the funds via reverse repurchase agreements involving some of the huge portfolio of mortgage-backed securities and U.S. Treasuries that it acquired as it fought the financial crisis, the newspaper reported, without citing any sources."
A recent Bloomberg story ("Negative Bond Returns Converge With Mortgage Miracle") said, "Central banks are discussing using reverse repurchase agreements to drain reverses, according to people with knowledge of the talks. In the transactions, the Fed sells securities to the dealers for a specific period, temporarily decreasing the amount of money available in the banking system."
Bloomberg's initial piece, "Fed Said to Start Talks With Dealers on Using Reverse Repos,", said, "As the supply of Treasuries increases, which occurs when reverse repos take place, repurchase agreement rates are typically pushed higher. The rate on collateralized loans in the more than $5-trillion-a-day repurchase agreement market, where Treasuries are borrowed and lent, is already higher than the amount changed for unsecured borrowing of federal funds."
This week's "Short Term Market Outlook and Strategy" from JPMorgan's Alex Roever and Cie-Jai Brown explains, "Expanding repo books, even with the Fed as a counterparty, have capital implications that will effectively limit each dealer's interest at some level. For this reason, published news accounts indicate the Fed is considering doing term reverses with money funds. This introduces its own set of issues. For instance, would the Fed deal directly with the funds, or would it try to affect these trades via the existing primary dealers? It's hard to imagine the Fed quickly developing and deploying the complex procedures and systems needed to deal directly with the money funds.... Operationally it would be much easier to use the primary dealers, but capital considerations interfere here as well. One possible solution would be to immunize primary dealers against capital charges related to Fed reverse repos and money funds, similar to what was done for the banks that facilitated the AMLF."
JPM continues, "Also consider the administrative and approval processes the money funds would have to go through to approve the Fed reverses as an asset class. These are not necessarily trivial.... The funds will need lead time to approve the product, and they can't do that until all the details have been determined. All of this suggests it could be months before the money funds are able to do reverses. On top of this is the issue of how the new SEC money fund rules will view these trades. Under the current proposal, term repo is an illiquid asset, and as such would not be an eligible asset, unless the Fed managed to sidestep the rule by getting a no-action letter from the SEC or perhaps by giving the funds a put option back to the Fed. Ultimately, while we don't doubt there is a market for Fed reverses in the money funds, we do doubt the proposition that it will develop quickly."
