The Fed's reverse repurchase balance fell below the 500 billion US dollar mark for the first time in more than two years. Market liquidity once again turned red, and the risk of a liquidity crisis breaking out in March is increasing.

According to the latest data released by the Federal Reserve, on February 15, local time, the Fed's overnight reverse repurchase (RRP) balance fell by US$82 billion to US$493 billion from the previous day, falling below US$500 billion for the first time since June 2021.

This is also the biggest non-month-end decline since October last year, which is quite shocking because the use of reverse repurchases has been relatively stable recently.

As Curvature analyst Scott ED Skyrm notes:

This is even more surprising given the ease of funding.

When the repurchase rate is low, reverse repurchase usage often falls less because the 5.3% reverse repurchase rate is more competitive than the market rate.

The reverse repurchases are likely to run out completely in March of this year. Meanwhile, some expect the reverse repurchase balance to remain at a “continuously low level” of $200-300 billion.

Is there a big show in March?

It's worth noting that running out of reverse repurchases is probably just one part of the “March Drama” play.

Repurchase rates have jumped several times since the fourth quarter of last year, releasing price signals of liquidity pressure.

Additionally, the Bank Term Financing Plan (BTFP), an emergency relief tool introduced by the Federal Reserve during the banking crisis last year, will expire in March and will not be renewed, and banks will be forced to fund their $160 billion gap through a discount window.

All of this suggests that liquidity risks may erupt intensively in March.

At that time, the Federal Reserve will once again be forced to stand at a crossroads. What choices will it make to deal with the crisis?

Is it an interest rate cut? End of QT? Or even turn on QE?

Dallas Federal Reserve Chairman Logan pointed out as early as January that the Federal Reserve should slow down QT as the reverse repurchase balance approaches a low level.

In the same month, Bill Gross, known as the “king of old debt,” said that if he were the chairman of the Federal Reserve, he would stop QT now and start cutting interest rates in the next few months to avoid a recession.

Some Wall Street strategists have previously suggested that the Federal Reserve should completely stop QT until the reverse repurchase balance is close to zero.

Some analysts also believe that it was too late for the Federal Reserve to stop quantitative austerity at that time, and sharp fluctuations in the treasury bond market could not be avoided. Hedge funds will be the “trigger” for rapidly reducing market liquidity. Even if the Fed risks a resurgence in inflation, it will end QT and resume QE within the next few months.

QE might not be the benchmark option, though.

Although liquidity risk is gathering, it is currently difficult to determine whether and when it will break out.

Despite the exhaustion of RRP and the expiration of BTFP, the Federal Reserve also has two policy instruments, the Domestic Standing Repurchase Facility (SRF) and the International Repurchase Facility (FIMA), which have perfected the “interest rate corridor” mechanism to prevent overnight interest rates from regularly breaking through the upper interest rate limit as liquidity tightens.

In addition, Federal Reserve officials are also publicly encouraging lenders to freely use the central bank's discount window for financing, and they hope to use this financing instrument as an important tool for maintaining financial stability and monetary policy.

Therefore, fluctuations in repurchase interest rates and the significance of BTFP should not be overstated.