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Federal Reserve Imposes Cap on Reverse Repo Facility, Rate Falls to Zero

The Federal Reserve limited its reverse repo facility to $300 billion per day as of September 22 in order to address concerns that a facility of unlimited size could worsen issues during periods of market stress. With the reverse repo facility, the Fed accepts cash from participants in exchange for securities as collateral, reversing the transaction the next day and paying participants a fixed interest rate, generally set at 0.05%. While the cap is usually above the average daily demand, on the last day of the quarter, as balance sheet constraints add up, demand generally surges above $300 billion. Where the demand exceeds the Fed’s limit, the facility uses an auction-type process where the lowest interest rates are prioritized until the cap is reached, leading to a situation where rates could actually turn negative. Rates dropped to near zero at the facility at the quarter ended September 30, and the general collateral repo rate (measuring the rate in private markets) went negative. With the Fed unwilling to accept the excess demand, those looking for a secure place to invest cash overnight must accept lower rates (sometimes paying to store cash), leading to even lower returns for money market funds managers.

An FAQ regarding the Fed facility can be found here. The Wall Street Journal and Bloomberg covered the developments.