Skip to main content
All posts
2 min readTapeboard Staff

What is a Reverse Repo? Definition, Formula, and Example

A reverse repurchase agreement (reverse repo) is a transaction where one party sells a security and agrees to buy it back at a higher price, effectively lending cash against collateral overnight — and the Fed's overnight reverse repo facility (ON RRP) is the floor of U.S. short-term interest rates.

glossarydefinitionsrates

What is a Reverse Repo?

A reverse repurchase agreement is the cash-lending side of a repo transaction: one party buys a security (typically a Treasury) with an agreement to sell it back the next day at a slightly higher price, earning the difference as interest. From the cash lender's perspective it is a collateralized overnight loan. The term dominates market discussion because of the Federal Reserve's Overnight Reverse Repurchase Agreement Facility (ON RRP), where money market funds and other eligible counterparties park cash directly at the Fed and earn the ON RRP rate. That rate sets the effective floor under all U.S. money market rates — no rational lender accepts less than the risk-free rate available at the Fed.

How a Reverse Repo Works

The economics are a secured loan:

  • Party A (cash lender) buys $100 million of Treasuries from Party B.
  • Next day, Party B repurchases them for $100,013,889.
  • The $13,889 difference is one day of interest at 5.00% annualized:

Interest = Principal × Rate × (Days/360)

= $100,000,000 × 0.05 × (1/360) = $13,889

For the Fed's facility, the ON RRP rate is set administratively by the FOMC (at the bottom of the target range, or 5 bps below the top), and usage is measured in daily take-up volume reported by the New York Fed.

Worked Example

In mid-2023, the ON RRP facility peaked above $2.3 trillion per day — money market funds were parking over $2 trillion at the Fed earning 5.30% rather than buying T-bills or lending to banks. As the Treasury issued more bills and money funds rotated into higher-yielding paper, ON RRP balances drained steadily through 2024, falling below $200 billion. Traders tracked this drain obsessively: while RRP balances fell, the runoff of the Fed's balance sheet via quantitative tightening was absorbed by the RRP rather than by bank reserves, keeping funding markets calm. Once the RRP buffer emptied, QT began biting directly into reserves — the risk regime shifted.

When Traders Use It

  • Liquidity monitoring: RRP balances are a weekly gauge of excess cash in the system; a drained RRP means QT now hits bank reserves one-for-one.
  • Rate floor analysis: When repo rates trade below the ON RRP rate, collateral is scarce; above it, cash is scarce.
  • Money market positioning: Funds arbitrage between T-bills and the RRP — the bill/RRP spread drives flows.
  • Stress signals: A sudden RRP surge signals risk-off flight to the safest parking spot.

Limitations and Common Misconceptions

  • RRP balances are not "money on the sidelines" for equities: That cash belongs to money funds serving institutional liabilities; it does not rotate into stocks.
  • Zero RRP does not mean zero liquidity: Reserves, the TGA, and the standing repo facility all matter; RRP is one buffer among several.
  • The rate is a floor, not a target: The Fed sets policy via the fed funds range and IORB; the ON RRP rate is a supporting tool.
  • Counterparty limits cap usage: Per-counterparty caps mean the facility cannot absorb unlimited cash in a panic.