$28.8B and Falling: The Fed’s Backstop Craters as $2.8T in Overnight Leverage Runs Hot

Yesterday’s reverse repo take-up cratered to just $28.818B — a level we haven’t seen since 2021.

The collateral hasn’t vanished; it’s sitting in the Fed’s locker, untouched. But the market’s telling you something: cash would rather hunt yield in T-bills and “hot” private repo than take the Fed’s 4.25% overnight.

That decision flips the system’s safety net upside down. The official shock absorber isn’t gone — it’s idle. Meanwhile, demand in the private collateral market intensifies, where scarcity drives specials higher, drains dealer balance sheets, and shortens fuse lengths on any spark of stress.

It’s the paradox of modern market plumbing: the life raft is tied to the dock while the currents grow faster. The RRP’s decline isn’t relief — it’s the quiet reallocation of liquidity into more fragile channels, where strain compounds and small shocks can travel farther, faster.

The Double-Edged Drain: How RRP Collapse and SOFR Swell Prime the System for Shock

When reverse repos plunge because money market funds chase hotter yields in T-bills or specific repo “specials,” it’s not just a footnote — it’s the quiet removal of the market’s emergency airbag. That instantly-available pool of pristine Treasuries in the Fed’s locker isn’t gone, but it’s inert — and in a crisis, inert means useless. That’s the first domino.

Now bolt that to the second: SOFR volumes have been making new highs every few months since 2023.

More SOFR volume isn’t just “liquidity,” it’s collateral being churned through overnight loans, positions rolled and re-rolled in a 24-hour survival loop.

In calm waters, it works. In a storm, it’s gasoline. Repo must reprice risk instantly. Without a deep RRP backstop, those adjustments can detonate into violent rate gaps — just like September 2019, when repo blew out to 10% in hours.

When that spark hits:

• Funding costs explode → Margin calls cascade through leveraged trades.

• Forced deleveraging begins → Treasuries sell first, contagion bleeds into equities, credit, EM.

• Feedback loop ignites → Rising yields force more sales, sales force yields higher.

By the time money market funds (MMFs) reprice risk and shift allocations, the funding market can already be seizing up. The problem isn’t just “can they go back?” — it’s “can they go back before the damage snowballs?”

Put simply: money market funds bypassing the Fed strip away the crash pad, while record overnight leverage stacks the load higher. The next shock will hit a system running full throttle with no brakes.

Why the RRP Drains

It’s not just yield. MMFs bypass RRP when they value flexibility more — keeping cash mobile to grab scarce T-bills or repo “specials” the moment they appear. Even if RRP’s 4.25% looks good, tying cash there overnight means missing intraday collateral wins.

Why That’s Fragile
When everyone hoards dry powder in the open market instead of RRP:

• The Fed’s instant collateral buffer shrinks.

• More cash chases the same scarce paper, pushing specials richer.

• In stress, repo rate spikes feed on themselves faster — and in a record-leverage environment (SOFRVOL near highs), that can turn a blip into a crisis.

Why Higher SOFR Volumes Amplify the Risk

• SOFR volume measures how much is borrowed/lent overnight in the secured funding market — it’s been making new record highs every few months since 2023.

• Higher SOFR volume = higher leverage = more positions dependent on rolling over funding every day.

• With less RRP cash as a backstop, any disruption in rolling that leverage — even for a day — can cause forced deleveraging.

The Feedback Loop

1. Money market funds chase yield → drain RRP.

2. RRP cushion shrinks → less capacity to absorb repo rate spikes.

3. SOFR volume stays high/keeps rising → more fragile positions to shocks.

4. Minor funding stress → repo rates jump above RRP rate → more money market funds avoid the facility → stress escalates faster.

Dysfunction in the Middle of the Curve Makes Matters Worse

• The 10-year swap spread at −26.5 bps shows investors are still preferring synthetic interest rate exposure over real Treasuries, implying that cash UST liquidity is impaired.

• This isn’t good — when the market avoids holding actual bonds, it creates extra pressure on the front end, where liquidity is deepest.

• That pressure pulls collateral demand toward the shortest maturities, draining RRP even faster.

RRP at 28.8B: A Shrinking Backstop in a Market Running Full Throttle

Reverse repos just collapsed to $28.818B — the lowest since 2021 — not because collateral is gone, but because money market funds prefer chasing hotter yields and intraday opportunities in T-bills and “specials.”

That choice sidelines the Fed’s instant backstop while swelling SOFR volumes ($2.796T) keep leverage at full throttle. In stress, with the 10 year swap spread deeply negative and cash UST liquidity impaired, repo can gap violently, triggering margin calls and forced selling. The system is now running faster, with less shock absorption — a market priced for perfection but structurally primed for contagion.

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Luke Lovett
📲 Cell: 704.497.7324
🌐 Undervalued Assets | Sovereign Signal
📧 Email: [email protected]

Disclaimer:
This content is for educational purposes only—not financial, legal, tax, or investment advice. I’m not a licensed advisor, and nothing herein should be relied upon to make investment decisions. Markets change fast. While accuracy is the goal, no guarantees are made. Past performance ≠ future results. Some insights paraphrase third-party experts for commentary—without endorsement or affiliation. Always do your own research and consult a licensed professional before investing. I do not sell metals, process transactions, or hold funds. All orders go directly through licensed dealers.