The Fed's vacuum

what is it sucking up?

The Fed has been busy at the reverse repo window lately. Below is the latest data on overnight reverse repurchase agreements. It updated yesterday, August 9th.

As a reminder, the reverse repo operations of the central bank puts collateral in the hands of banks. Banks give cash to the Fed and in return get short-dated treasuries.

Since the beginning of the year, the Federal Reserve has participated in over $45 trillion dollars worth of reverse repo operations. For a little perspective, the Fed had participated in nearly $4.1 trillion in reverse repo operations prior to 2021.

This reverse repo facility is one powerful vacuum as it is sucking up over 10x the money it has ever sucked up in the past.

Here is the full historical picture of the reverse repurchase operation at the Fed.

We are in uncharted waters at the present time. But fear not for John Williams, the New York Fed President has stated that this is all working exactly as designed.

"It's effective and I'm not concerned about the amount of uptake on that ... or whether it would increase further," Williams told reporters. "It would just be a sign that it's working as planned."

Usage of the program has skyrocketed since the Fed increased the rate it pays in reverse repos to 0.05%.

The banks are parking huge amounts of money in overnight reserves at the Fed. When the Fed is going to pay them to do so, I don’t blame them. This is a risk-free trade in the eyes of the banks. This activity, however, stifles lending to businesses. Bottom line, banks are putting money back at the Fed instead of putting it to work in the economy. Doing this smothers some of the money pump activities of the Fed and should be monitored closely.

The most important thing to remember is that the Fed can reverse this activity at any time. By increasing interest rates on reserves or lowering the reverse repo rate back to zero, banks would go elsewhere to get a return on their money.

By John Williams stating that this facility is “working as planned”, it signals to me that the Fed is doing this on purpose. They want to suck up funds from the system and this facility allows them do to that. They are wielding the most powerful vacuum in the world. I worry that as the use of this facility gets larger, it is going to cause the market to get unstable.

Right now this vacuum is sucking down the inflation-hedges without pulling down the broader market. We’ll see how long the Fed can keep it up.

M2 money supply data is released next on Tuesday the 24th. At that time, I will be taking a deeper dive into how much power the Fed’s vacuum has on the money supply.