Chart of the Week | Bitcoin vs the Reverse Repo

Good morning everyone and welcome to our Chart of the Week series! Every week we provide you with one of the most informative Bitcoin charts, sent directly to your inbox.

This week we dive into the RRP (aka the ‘Reverse Repo’) to understand how it impacts liquidity sensitive assets like Bitcoin.

Let’s dive in!

If you have spent more than a few minutes in Bitcoin twitter recently, you will have heard endless discussion about the level of the Reverse Repo (sometimes abbreviated ‘RRP’), and how the draining will impact liquidity-sensitive assets like bitcoin.

So, what is the Reverse Repo, and why does it really matter?

What is the Reverse Repurchase Program?

The Reverse Repurchase Program is a construct of the Federal Reserve. Its an overnight lending facility, where banks and other financial institutions can loan excess dollars to the Federal Reserve. These overnight loans are taken in the form of treasury bills, where banks can purchase short-term bills, and get that money back from the Federal Reserve at the end of the loan (typically overnight).

Essentially, the Reverse Repo Program was used as a way to ‘sterilize’ excess liquidity that was produced during the COVID-era. By operating this facility, the Federal Reserve was able to remove excess liquidity out of the real economy, and ‘sterilize’ it in the form of an overnight loan.

The RRP Interest Rate

As previously mentioned, these overnight loans that take place in the Reverse Repo Program have an interest rate that the Federal Reserve pays the lender. The Federal Reserve could tailor the rate, to have certain impacts on various components of the economy, ranging from treasury demand to liquidity/inflation expectations.

An example of how the RRP worked in practice: the overnight RRP interest rate was 4.25% and a 3-month treasury bill yields 4.32%. By setting the RRP rate lower than the market rate for a short-term treasury bill, the Fed could indirectly guide liquidity into those treasury bills.

By manipulating this RRP rate, the Fed could therefore, help guide interest rates.

Impacts on Liquidity

As previously mentioned, the RRP allowed the Federal Reserve to essentially sterilize excess liquidity and remove it from the broader economy. The mechanics of this were as follows: instead of a bank taking their $1B and loaning it out into the economy (with a higher monetary velocity), the Federal Reserve could sell that bank treasury bills (on an overnight basis), and that money is never loaned out into the real economy.

This also, of course, works in reverse. Now that the RRP is almost completely empty, this means there is no longer ‘excess’ liquidity out in the economy. However, as our previous article titled “Bitcoin and Liquidity” made clear, liquidity is an aggregate measure, taking into account many different factors that drive overall liquidity in a system.

So, what does the overall liquidity picture look like? Well, it’s not nearly as scary as the “RRP doom” posting you may have seen. In fact, overall liquidity looks set for another leg higher after a period of consolidation:

How does this Impact Bitcoin?

Bitcoin, being highly sensitive to liquidity, has broadly followed this overall liquidity measure. Key to watch in the future will be the direction which things start to move from here. If inflation continues to moderate and unemployment does not meaningfully increase, we may see a longer period of consolidation in the above trend in liquidity.

Also key to remember in this discussion is the role of the fiscal dominance regime, which we seem to be firmly planted in. As the debt ceiling debate approaches, government spending along with broad fiscal concerns, will be absolutely key to watch.

That’s it for this week - remember to stay humble out there folks and continue stacking sats!