No Reserving Interpretation About Reverse Repo Collateral Connection(s)

Why are Treasury bills the best of the best, the purest of the most pristine? The better part of the answer comes in the form of a mere three letters: O, T, and R. Those happen to stand for on-the-run which in repo simply means dependably liquid. OTR securities are those most recently auctioned thereby the specific securities which have under them the most robust and dependable (read: highly liquid) market.

This matters more than anything because as a repo cash lender all you care about is if you are able to sell the collateral tomorrow morning should the cash borrower – who gave you the right to seize and sell – default allowing you to exercise this last option and liquidate the asset to get back your cash.

As many repo MBS participants found out in the hot summer of 2007, having a dependable liquid market means the difference between repo being repo or facing potential serious losses (firesale) on what is otherwise supposed to be the safest funding arrangement.

T-bills are OTR; only handfuls of notes and bonds are also. Big advantage to the bills (as the world rediscovered in horror in March 2020).

There are other risks to consider, too. Price risk to the cash borrower, for one. Posting, say, a longer-term instrument whether Treasury or some other kind exposes the funding transaction when rolled over repeatedly to potential adverse price factors. For debt instruments, this means largely inflation/growth risk when the bond market greets both those things negatively by lowering prices over time.

You start out with $100 10-year UST notes valued at $99 in repo, but then reflation hits and within a short while inflation potential reprices some of that collateral right out from under you. This can and does impact both the collateral owner as well as the cash lender who might wish to alter haircuts should reflationary selling strike any market, such as bonds in January and February.

The shortest forms of debt, on the other hand, these don’t exhibit much by the way of the same non-liquidity price factor risks like inflation. Treasury bills, in other words, again are in higher demand overall as their limited maturities (and near-constant OTR source, refreshing features like the discounting rate) likewise limit this risk. They are inherently price-steady.

Double advantage bills.

But what if there aren’t enough bills?

If that’s the case, we wouldn’t know it via any direct assessment or data. Even though repo and collateral (as well as collateral for derivatives) have been front and center in every major acknowledged and unacknowledged monetary shortage since Summer 2007, these have yet to make much way into official and mainstream assessments which continue monolithic focus on bank reserves.

As we pointed out just recently, the FOMC only a few weeks ago issued a partial, half-hearted confession about how Treasury repo can make waves in the monetary realm no matter the level of bank reserves. Nearly fourteen years later, the central bank world has only now begun to ponder these implications more seriously – and once they do so more completely, it will rock monetary policies to their very core (accounting for so much time wasted to try to explain reality, their inflation “puzzle”, for one, any other way).

This the state of affairs, there is again no way to directly determine the systemic collateral condition. Yesterday, we examined this possibility from perhaps an unusual angle – the Fed’s reverse repo facility (RRP). Today, the window saw another bump higher in usage, bringing the afternoon total to more than $450 billion.

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Disclosure: This material has been distributed for informational purposes only. It is the opinion of the author and should not be considered as investment advice or a recommendation of any ...

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