According to Yahoo News, demand for a seldom-used Federal Reserve facility, the Standing Repo Facility (SRF), reached its highest level since 2020 this week. This comes as interest in testing the liquidity backstop has increased due to recent volatility in the funding markets. On December 5th, eligible banks borrowed reserves at 5.50% in exchange for Treasury and agency debt, totaling $203 million. This is the highest amount since July 2020, but still a small sum compared to the peak of $153 billion in March 2020. Demand for the facility dropped back to $6 million on Wednesday.
Market participants are closely monitoring the SRF for any signs of instability as the Fed has been unwinding its balance sheet for the past 18 months and excess liquidity is dwindling. Funding costs rose after month-end as dealer balance sheets lacked capacity to provide funding and traders needed to finance long Treasury positions. This pushed the Secured Overnight Financing Rate (SOFR) to a record-high 5.39% and put investors on alert for more market disruption. According to Steven Zeng, a strategist at Deutsche Bank AG, the increased usage of the SRF is likely due to a specific bank testing the facility after the recent SOFR jump.
The central bank reintroduced repo market operations in September 2019 amid turmoil caused by increased government borrowing, which exacerbated a shortage of bank reserves. The backstop was made permanent in July 2021, when the monetary authority was still adding more reserves to the financial system through quantitative easing. Over the past two years, banks had been slow to sign up for the SRF, leading some to question its efficacy. However, in the past two months, five banks have been added as counterparties, bringing the total to 25, including the New York branch of Norinchukin Bank on December 1st.