The Federal Reserve continues to test its Fixed Rate Reverse Repo program, where it “borrows” currency from the banking system collateralized by the UST’s in its immense SOMA portfolio. These reverse repo “tests” may continue until January 29, 2014 (at least under current authorizations). Because they are fixed rate, full allotment, the Fed had set $500mm maximum bid amounts for last week’s “auctions.”

Last Monday’s test received 76 bidders “lend” $11.8 billion to the Fed  at 0.01% collateralized, or $155mm on average;  Tuesday 75 bids for $12.7 billion or $170mm per bid on average; Wednesday 44 bids for $6.2 billion or $140mm average; Thursday 55 bids at $9.4 billion or $170mm average. Friday, there were only 50 bidders but the total increased to $16.6 billion, or $332mm on average.

To ramp up the testing, the Fed increased the maximum to $1 billion per bid, and suddenly they garnered 87 bidders “lending” $58.2 billion. That amounts to nearly double Friday’s rate, averaging $669mm per bid. That it would jump to nearly $60 billion may tell us a little about the economics of collateral markets.

Remember, these tests, from the market rather than Fed perspective, are all about collateral. Going off at 0.01% is not going to attract nonbanks to park cash (the purported aim of the program, bridging the bank/nonbank fragmentation). Why lend to the Fed at 0.01% in a test than 0.043% (last GC repo rate)? Those participating in the test are giving up that (paltry) opportunity costs for their cash for the same reason so many UST repo rates are slightly negative.

Back on August 20, under the Fed’s previous “fixed allotment” reverse repo test, $51.969 billion in bids were received in competition for a $5 billion slice. The stop-out rate was 0.01%, but bids were as high as the IOER at 25bps. That was more indicative of cash lenders actually trying to participate. The $58.2 billion all at 0.01% today is not the same bidder profile as the August 20 test.

While it is difficult to draw any hard conclusions about the change in a single test parameter on a single test day, it is interesting to say the least that there appears to be a scale consideration in collateral demand. We will have to see what happens to bids and bidders should/when they change the fixed interest rate parameter in upcoming tests. As I have said since this program was announced, its success or failure once unleashed is wholly dependent on the Fed getting the parameters correct. Since this is not a “market-based” program, the central planners need to be more right than wrong in their balancing act.

 

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