By Gertrude Chavez-Dreyfuss

NEW YORK (Reuters] – Investors are left with few options when there is a reduced supply of short term bills at the U.S. Treasury Department. This has led to a surge in demand for Federal Reserve’s reverse repurchase facility (RRP).

Open Market Trading Desk at the New York Fed conducts reverse repos. A reverse repo is where market participants lend money to the Fed overnight at an interest rate 80 basis points in return for Treasuries, other government securities and a promise that they will buy them back.

GennadiyGoldberg (senior rates strategist, TD Securities New York) stated that the RRP balance continues to rise.

“That’s because there is an extreme demand for front-end assets. Second, it has continued to fall as Treasury has reduced supply due to fairly strong tax collections.” he said.

On Monday, the Fed’s Reverse Repo Window attracted $2.045 trillion. Financial institutions continue to flood it with liquidity in return for Treasury collateral. Monday’s volume was just one in a string record for RRPs.

Investors can get overnight cash at 80 basis points without the risk of counterparty.

This is compared to the 51-basis point yield on U.S. one month bills. A longer maturity carries higher risk.

The RRP volume fell to $1.987 trillion on Tuesday due to the cash outflow from Fannie Mae, a government-sponsored enterprise. Freddie Mac (OTC:). GSE cash flow has a major impact on the performance of the repo markets.

Fannie Mae cash and Freddie Mac cash typically go into the repo markets on the 18th each month after they have received principal and interest mortgage payments. GSEs pay the mortgage-backed security holders on the 24th or 25th of each month. The repo market then withdraws that cash to MBS holders.

SHINKING BILLS SUPPLIED

The Treasury will need to decrease bill issuance until Sept. 30 in order for the U.S. Budget deficit to shrink amid high tax revenues.

Joseph Abate is the managing director of fixed income research. He stated, “A sharp fall in bill supply will push many of the cash money into the Fed’s RRP. Draining bank reserves drains by more than 1 trillion this year.” Barclays (LON:).

Between April 1, and September 30, he expects that the bill supply will shrink by 15%.

According to TD Goldberg, “It is really a double whammy at the front end due too much demand but not enough supply. This leaves the RRP facility the last resort option for many investors.”

Given that the Fed will begin quantitative tightening next month, it does not appear to be concerned by RRP volumes rising. However, it can be problematic if the Fed has to reduce its asset portfolio. Lou Crandall from Wrightson, chief economist, warned that this could lead to a rise in demand.

He also noted that Fed hawks had last winter used the excessive RRP facility as an excuse to clean up the Fed’s balance sheet by implementing asset runoffs.

Crandall suggested that individuals FOMC (Federal Open Market Committee), members may start to voice their opinions on the subject if there are higher RRP volumes than $2 trillion this year.