Every day in the early afternoon, money-market traders are glued to the Federal Reserve
Bank of New York’s website to see the results of the overnight reverse-repurchase agreement facility.
They’re not the only ones.
A screenshot of this obscure but important facility’s daily usage is religiously uploaded to a Reddit
forum called Superstonk, a discussion board similar to WallStreetBets where users swap memes and stock tips. As usage of the facility swelled, the post regularly became one of the site’s most popular of the day, often attracting thousands of comments.
While professional traders check the central bank’s website to see how much excess liquidity the Fed is sopping up, many Reddit
users are interested in, well, something else: Signs of an impending market crash. Or, in some cases, you guessed it: more evidence for why stocks like GameStop Corp. are headed “to the moon.”
“Ok this is actually f---ing ridiculous how the market isn’t tumbling after seeing all this lmao I can’t believe these f---s are this f---ing stupid,” wrote one Reddit
user who goes by the handle BarryRoadCrusader.
If this all sounds a little weird, that’s because it is. There is no way for the type of individual traders who frequent Reddit boards to use the facility, yet the posts appear to be influencing their trading. And the behavior is worth scrutinizing because it’s the type of hive-mind theorizing that has a habit of beginning as a social-media curiosity and ending up having big effects in the real world, such as the wild price action in meme stocks earlier this year.
Fed’s Reverse Repo Explained
The Fed’s facility, which is typically referred to as reverse repo or RRP, shares some common traits that have proven to be fertile ground for other types of anti-establishment, conspiratorial thinking: Obscure and complicated systems that are perceived to be controlled by elites and prone to misinterpretation by novices trying to understand them.
And to the credit of some Reddit posters, the fact that the financial system needs to park more than $1 trillion in the facility each night is without question evidence that these are not normal times. “It's not risky to put your money into the RRP. The problem is they have nowhere else to put it in. These high scores show us that something is wrong in the market, not the RRP,” user “pblokhout” posted on Sept. 23, adding a profane analogy about how people will buy napkins when the supermarket is out of toilet paper.
That’s similar to the way it’s being viewed by a Reddit user who goes by “oldmanrepo,” a retired repo trader named Tim who tries to stem the tide of misinformation that floods the forum. He’s no stranger to laymen misunderstanding the market: For the first five years of his career in repo, he was pretty sure his mother thought he was stealing cars. Tim asked that his full name not be used out of concern for his safety, given the zeal of some of the Superstonk regulars.
“The RRP is like crutches,” Tim said in an interview. “If you see someone walking down the street using crutches, you don’t think something bad is about to happen. It already did, and now they need the crutches to get healthy again. The Fed flooded the market with liquidity and the RRP is now being used to mop it up. It doesn’t tell of a bad thing to come. It tells of a bad thing that happened.”
The bad thing that happened, of course, was the Covid-19 pandemic. To combat the economic carnage that came along with it, the Fed and U.S. government both pursued stimulus policies in order to safeguard the economy. For the central bank, that meant buying up Treasury and mortgage-backed securities from banks in exchange for reserves. The Treasury, meanwhile, issued a slew of bills to ensure it had enough cash on hand to cover stimulus programs that passed Congress. While the proceeds of the bill auctions were waiting to be spent, the amount of cash held in the Treasury’s account at the Fed soared to a record $1.83 trillion.
The Treasury’s cash pile has since shrunk to about $260 billion. But as that buffer receded, the money made its way into the financial system via bank balance sheets. Now, banks and money-market funds are sitting on a mountain of cash with very few places to put it. And because investors are all competing for the same assets, that has pushed yields on short-term paper — anything maturing in less than one year — close to zero or below. That makes the Fed’s reverse repo facility a more compelling investment for those who have access — even though it only pays 0.05%.
While Reddit’s fascination with reverse repo began in earnest in May, the facility was started in 2013 in an effort to prevent short-term U.S. interest rates from going below 0%, making it an essential part of the financial system’s plumbing. In anticipation of greater demand for the facility, the Fed boosted the size of the counterparty limit in March of this year — followed by a doubling of the cap in September — and made changes to counterparty eligibility criteria to make it more accessible.
The posters on Superstonk have followed along all the way, even though prophecies of financial doom have so far gone unfilled. “Well, we somehow got through October without the big market crash,” user “bahits” wrote on Oct. 29. “The longer they wait and kick the can, the bigger the splash.... or splat.''
How Does Overnight Reverse Repo Work?
The repurchase agreements drawing all of the social-media attention are basically secured loans, in which one party sells securities to another and agrees to buy them back in the future. When it comes to the Fed’s overnight reverse repo, eligible counterparties, such as money-market mutual funds and government-sponsored enterprises like Fannie Mae and Freddie Mac, purchase securities from the central bank and agree to sell them back the next day.
Here’s how it works. Every weekday between 12:45 p.m. and 1:15 p.m. New York time, eligible participants in the program submit propositions electronically to what’s known as the FedTrade system. They detail the amount -- in increments of $1 million and not exceeding $160 billion — that they want to invest in RRP along with a desired interest rate that doesn't exceed the specified offering rate, currently 0.05%.
Then the total amounts are posted on the New York Fed’s website… and Reddit does its thing.
Such internal workings of the financial system like this are rarely discussed among stock-market investors. And because it’s a lubricant for the world’s financial system, people outside of this corner of the market only seem to pay attention when something breaks, like in September 2019, when a confluence of events pushed the rate for these overnight loans as high as 10%, forcing the U.S. central bank to intervene.
Yet as usage of the program began rising consistently, the Reddit user “pctracer” began posting the results each day, starting on May 26. To this observer, the swelling sums are “more an indicator of what’s going on and what we are going to expect. Numbers here are out of control, a very BIG crash is incoming.” The Reddit user said they began tracking the facility at the beginning of May when the National Securities Clearing Corp. proposed changing the frequency at which it may collect supplemental liquidity deposits in order to respond to liquidity shortfalls. It was around May 12 that pctracer noticed that a lot of stocks became correlated somehow, “and the RRP started being abused,” they wrote in a message. Pctracer, who declined to give his or her real name, added that they believe GameStop is a once-in-a-lifetime opportunity and "maybe even one in a millennium opportunity."
From there, the lore of the RRP took on a life of its own as usage of the facility continued to snowball, surpassing $1 trillion for the first time since its inception. For Reddit users trying to create some semblance of order in a universe that’s plagued by rising threats of inflation, supply chain disruptions and economic chaos, the reverse repo facility has become a blank screen for people to project their own ideas as to what the mammoth demand for the facility is signaling.
On the last day of the most recent quarter — when usage surged to an all-time high of $1.6 trillion — the post with the screenshot of the results generated about 2,000 comments.
Theories Around Reverse Repo
Here are just a few of the theories that have been floated in recent months:
According to a user who goes by “snowlock27,” banks are not lending, nor investing their excess cash. Instead they are parking it at the reverse repo facility because “they know something’s getting ready to happen.” Other commenters espouse a similar theory, that institutions aren’t putting cash to work in stocks because they fear an upcoming crash.
“Callingallnerdz” said hedge funds are overleveraged and if/when there’s a market crash, their collateral will fall, resulting in margin calls and requirements to close short positions that will cause shares of GameStop to “finally moon.”
Others, including “akatherder,” have said if demand for the RRP reached $1.3 trillion, it would cause a “reshuffling,” per “repo market God” Zoltan Pozsar, a strategist at Credit Suisse. As “googy_boogey” put it: “The big number to aim for was 1.3 trillion when someone important said that was when s--t would get bad but it just keeps going up.”
The Pozsar theory stems from a note the analyst wrote at the beginning of July, in which he said usage at the Fed’s facility could rise to $1.3 trillion by the end of August as money-market funds rotated out of Treasury bills in favor of the higher-yielding RRP. That was realized in September when the balance at the RRP reached that level. Where Pozsar was wrong was the idea that either the higher yields available from the Fed's facility or from Treasury bills would pull money away from the banking system and bring reserve balances down below $3.5 trillion, thus sterilizing the effects of the Fed’s quantitative easing.
“That was a wrong view,” Pozsar said in an interview. “If that’s the stuff they’re running with, I think it’s time to move on. When facts change and things don’t move the way they thought they would, you get out of a position and move on.”
Still, even as Reddit users like Tim, who has more than 20 years of experience in the repo market, try to dispel some of what he calls the “tinfoil hat conspiracy theories,” participants in the discussion tend to chalk it up to criminal behavior on the part of banks.
Except the banks aren’t even the primary users of the RRP. At the end of the most recent quarter, money market funds accounted for $1.439 trillion of the record $1.605 trillion parked at the Fed’s facility, according to the Office of Financial Research data. The remaining $166 billion likely came from government sponsored enterprises and not banks. That’s because GSEs cannot earn any yield on their deposits parked at the Fed, whereas banks can earn 0.15% via the interest paid on reserve balances.
So even when the data says otherwise, why do these various theories live on?
“People become wedded to their narratives, and move away from them very slowly, especially if the narratives relate to issues to which they are attached, like GameStop,” said Hersh Shefrin, a behavioral economist and finance professor at Santa Clara University. “Sticking with one’s narrative, stubbornly, is consistent with confirmation bias or motivated reasoning.”
Observers may cull fragments of data that fit with narratives that are “intuitively appealing,” as opposed to doing real analysis to determine whether there’s any evidence supporting their claims, according to Shefrin. “Just look at the salty language that appears to substitute for careful analytical thinking,” he said.
This may be why some RRP watchers are still insisting that an eventual collapse in demand for the Fed’s facility will somehow harm hedge funds and send shares of GameStop soaring once again, even though hedge funds are not counterparties with the central bank.
As far as the central bank itself is concerned, New York Fed Executive Vice President Lorie Logan noted in April that the facility was becoming “more central in the framework” of keeping short-term interest rates within the target range. Since then, Fed officials have been clear that it is working as designed.
“The ON RRP facility is working as intended, even as usage expands to new highs,” Logan said in an Oct. 14 speech. “Just as usage of the facility grew in response to downward pressure on money market rates, it should decline in response to increases in them.”
Even as the U.S. central bank starts tapering its asset purchases, usage of the facility is unlikely to decline dramatically until the Fed outright stops buying securities — and stops creating reserves. As supply of securities returns to the market, it should draw rates higher and pull participants away from the RRP.
“I just need QE to stop so RRP starts going down,” Tim said. “Once they start tapering, yields will start to move up a bit and money funds will start to move cash out of the facility. They’ll all have to find a new narrative.”