Fed's Repo Facility Largely Unused as US Interest Rate Curve Shifts

The Federal Reserve's repo facility for foreign monetary authorities has been largely unused since its introduction. The facility allows approved foreign central banks to raise dollars by temporarily handing Treasuries to the Fed, rather than selling them in the market. This was seen as a way to prevent Japan from being forced to sell large amounts of Treasuries and causing long-term interest rates to rise.

However, the data shows that foreign official holders have reduced their Treasury holdings at the Fed by roughly $258 billion over the past year, despite the facility's existence. Meanwhile, the Fed has bought $338 billion of Treasuries concentrated almost entirely inside one year.

The result is a long-term interest rate differential between the US and Japan that is narrower than expected. Japanese government bond yields have risen sharply, making it more attractive for Japanese institutions to buy domestic bonds rather than foreign ones.

This shift in investor preference has significant implications for the Treasury market. The Fed's repo facility may not be needed after all, but its presence has still had a lasting impact on the US interest rate curve.