The U.S. Federal Reserve’s quantitative easing (QE) measures have pumped unprecedented liquidity into the financial system since the onset of Covid-19, causing M1 money stock to skyrocket. However, recent data reveals a sharp pivot: the Fed is aggressively draining liquidity through overnight reverse repo (RRP) operations. On Tuesday, May 25, the Fed conducted a reverse repo operation totaling $432.9 billion, a 23.07% increase from the $351 billion recorded on May 22.
Record-Breaking RRP Operations
The Fed’s RRP activity accelerated rapidly over a few days. After removing $351 billion on Saturday (May 22), the central bank drained $369 billion on Friday (May 21), $395 billion on Monday (May 24), and $432.9 billion on Tuesday. The number of counterparties participating rose to 48. Market participants speculated on social media that the RRP tally could soon exceed $500 billion. “Fed Reverse Repo 432.955 Billion from 48 counterparties Repo market is still broken, broken. We’ll break 500 billion tomorrow,” one user tweeted.
Mechanism and Market Interpretation
RRP operations are the opposite of QE: the Fed sells Treasury securities to counterparties to withdraw reserves from the banking system. So far, only Treasury securities have been involved, with no mention of mortgage-backed securities (MBS). Scott Skyrm, executive vice president in fixed income and repo at Curvature Securities, explained to Market Watch columnist Joy Wiltermuth: “Either there is too much cash or not enough collateral. It’s two sides of the same coin.” A BTIG Research team led by Julian Emanuel described the situation as a “game of cat and mouse,” suggesting the Fed may be testing the market’s capacity to absorb excess reserves.
Historical Context: Unprecedented Money Creation
Estimates suggest that the Fed’s M1 expansion in 2020 alone surpassed the cumulative creation of U.S. dollars over the previous two centuries. Approximately 24% to 30% of all existing dollars were created in 2020 and Q1 2021. The rapid ramp-up in RRP operations is seen by some analysts as a precursor to tighter monetary policy, which could have ripple effects across risk assets, including cryptocurrencies. As the Fed withdraws liquidity, markets may face renewed volatility.