Repo Rate Sensitivity to Treasury Issuance and Quantitative Tightening

Over the past six months, Treasury repo rates have risen, on average, relative to the rate on the overnight reverse repurchase agreement (ON RRP) facility and have become more volatile. Recent literature has argued that these trends have been driven, in part, by the cumulative effects of quantitative tightening (QT).2Specifically, during QT the Fed reduces its security holdings, which increases the amount of Treasury securities held by private investors. The reduction in securities holdings also results in a reduction in Federal Reserve (Fed) liabilities, which decreases the amount of Fed-provided liquidity. Both of these effects put upward pressure on repo rates. In this note, we study the sensitivity of repo rates to changes in Treasury securities outstanding—a proxy for net Treasury issuance—over time and how the sensitivity changes with Fed-provided liquidity. We find that over the 2017–19 QT period, the sensitivity of repo rates to issuance generally increased as the Fed's balance sheet shrunk in size and continued to be high amid low levels of aggregate liquidity, which persisted until March 2020. During the current QT period, this sensitivity has mostly been small and statistically insignificant; however, it has been increasing over the past six months. Even so, the recent increase in sensitivity remains far below the sensitivity estimates for the prior QT period, suggesting that liquidity remains abundant. We interpret these findings as evidence that QT contributes to the relative tightness of supply and demand conditions in the repo market, making rates more sensitive to changes in Treasury supply. Looking ahead, as QT continues, we expect the sensitivity of repo rates to Treasury issuance to increase.