UPDATE 1-Cash floods into Fed's reverse repo facility on final day of 2024

Adds background on Fed liquidity operations

By Michael S. Derby

Dec 31 (Reuters) - Cash flooded into the Federal Reserve’s reverse repo facility on Tuesday, the final trading day of 2024, pushing usage of the tool to the highest level since early summer.

Money market funds and other eligible firms parked $473.5 billion on the Fed’s books. The surge was not unexpected as quarter- and year-end periods often see big inflows of cash to the central bank as firms manage their balance sheets in what is usually a short-lived adjustment.

The inflows on Tuesday were the highest since $664.6 billion that flowed into the facility on the final trading day of the second quarter. Tuesday’s level also exceeds Sept. 30’s $465.6 billion uptake, which marked the closing of the third quarter.

The Fed’s reverse repo facility allows eligible firms to effectively loan cash to the Federal Reserve overnight. The reverse repo rate, now set at 4.25%, provides a soft floor for interest rates, and in conjunction with a rate the Fed pays deposit-taking banks for loans of reserves, the two rates manage where the federal funds rate trades.

That rate, which is the Fed’s primary tool for influencing the direction of the economy, stands at between 4.25% and 4.5% following a quarter percentage point cut earlier this month.

Quarter ends often bring volatility to money markets, which can increase demand to park cash at the Fed. The quarter end at the close of September was attended by unexpected levels of market chop and the first notable usage of the Fed’s Standing Repo Facility, which provides fast cash to program participants in exchange for loans of Treasury securities.

The Fed’s reverse repo facility has been steadily shrinking for some time and it is well under the $2.6 trillion peak hit on the final trading day of 2022. Reverse repo usage had slipped under the $100 billion mark on Dec. 20.

Wrightson ICAP analysts, who had reckoned as much as $350 billion might flow into the facility Tuesday, believe the higher usage level is short-lived, saying in a note “we continue to expect cash to flow back out of the facility rapidly after the New Year’s holiday.”

Fed officials have suggested that whatever happens Tuesday it is unlikely to be a sign that market liquidity has grown too tight amid central bank efforts to drain cash amid its ongoing contraction of its balance sheet.

“There's ample liquidity to see the financial system,” New York Fed President John Williams said just after the Fed’s December meeting, in a television interview. “I think we will see a little bit more pressures in the repo markets” at year end but not of the sort that will change the Fed’s assessment of broader liquidity trends.

One reason why the Fed has been unworried by bouts of market volatility is that it has yet to face any challenges managing the setting of the federal funds rate. But with the Fed having shrunk the size of its holdings from a peak of $9 trillion in the summer of 2022 to the current level of $6.9 trillion, officials are closely watching for signs liquidity is tightening in way that might threaten their control of their interest rate target.

At that point officials will likely stop the contraction of their holdings and stabilize the size of the balance sheet. So far, Fed officials have little clarity about the endgame and are watching markets to judge when liquidity has tightened too much.

(Reporting by Michael S. Derby; Editing by Chizu Nomiyama)

((Michael.Derby@thomsonreuters.com;))