Expert Commentary

Banks Scream for Deflation as they Drown in Liquidity

It is a sign that the Fed is going too far.

A “reverse repo” sounds like a judo or wrestling move you might hear in commentary at the Olympics. “And there it is, she wins the Gold after pinning her opponent with a stunning reverse repo!”

In actual fact, a reverse repo is an integral part of the financial system and its market has now come into sharp focus.

Usage of the Federal Reserve’s reverse repo facility has surged in the last couple of weeks. What this means is that banks and financial institutions are parking their cash balances at the Fed overnight in exchange for Treasury bonds. The next day, the opposite happens as the Fed repurchases (repos) the bonds and gives the cash back to the banks. Daily usage of the reverse repo facility hit $450 billion this week, the highest level since 2017, and unusual in that the surge is not occurring over a year or quarter-end date when previous spikes have emerged. Why is this important?

What this is telling us is that the financial system is now drowning in liquidity, with so much cash that it is struggling to find any use for. The only option for banks and institutions is to give the cash back to the Fed. This flood of cash going back to the Fed has reduced the Effective Fed Funds Rate to just 0.06%, in a target range of 0% to 0.25%. If this carries on, the Effective Fed Funds Rate will go negative.

This is most definitely a signal from the financial system that the Fed’s money printing has reached its limit. It’s a crazy situation whereby the Fed is purchasing bonds every month, with the counterfeited cash going to the market, but then having to sell the bonds in reverse repos because the cash has nowhere to go.

The financial system is telling the Fed it must stop its monetary inflation and let monetary deflation take its course.


Overnight Reverse Repurchase Agree- May 2021