The weekly Fed balance sheet report contains a line item “reverse repurchase agreements, foreign official and international accounts”. This represents cash placed with the Fed by overseas institutions against collateral in the form of Treasury and other securities.
These reverse repos surged after Lehman’s collapse in September 2008 and from the start of August this year as the Eurozone sovereign and banking crisis intensified. A possible explanation is that these events prompted foreign central banks managing official reserves to withdraw funds from US / European banks and place them with the Fed on "safe haven" grounds. The reverse repos, in other words, may serve as an indirect gauge of banking system funding stress.
Consistent with this interpretation, the reverse repos have correlated negatively – with a slight lead – with the relative performance of European financial stocks, as shown by the chart below.
The reverse repos peaked in early September and have fallen for three consecutive weeks, though remain historically high. The decline may be connected with the 15 September announcement of three-month US dollar liquidity-providing operations to be conducted by the ECB, Bank of England, Swiss National Bank and Bank of Japan over year-end, financed by currency swaps with the Fed. This announcement may have eased concerns about European banks’ dollar funding difficulties, thereby reducing reserves managers’ desire to hold cash at the Fed.
While European financial stocks have weakened further since early September, they have stopped underperforming.
A less encouraging possibility, however, is that the fall in the reverse repos, rather than reflecting a reduction in banking system stress, has been due to foreign central banks running down their Fed cash in intervention operations to support their currencies against a strengthening US dollar. Still, the deployment of Fed-held cash boosts US bank reserves and the monetary base.
A further decline in the reverse repos, therefore, would be a hopeful signal for markets.
