Abstract
This article explores the relationship between Reverse Repurchase Agreements (RRP) and Bitcoin price movements.
Takeaways:
1. RRP refers to the agreement that the Federal Reserve (Fed) enters into with the eligible counterparty, in which the Fed sells a security to the counterparty and agrees to buy back the security at a specified price at a specific time in the future.
2. RRP is an instrument used by the Fed to suck out liquidity from the markets by attracting investments from the markets themselves.
3. A higher RRP reward rate with a cumulative increase in the amount of RRP will decrease money supply in the market.
4. RRP has been sucking liquidity out of the market since mid-June when the RRP increase rate exceeded the rate at which the Fed was increasing its balance sheet.
5. The Inverted RRP may indicate sell-offs in equity markets (SPX/IXIC/Bitcoin) when it shows RRP increases, and vice versa.
6. Data shows that the Inverted RRP has the strongest correlation with SPX/IXIC/Bitcoin with a two-week leading window.
7. In conclusion, the Inverted RRP is a useful indicator as RRP directly drains out money supply.
8. The Inverted RRP indicator should be used together with other liquidity flow indicators for maximizing reliability.
1. What is RRP, and how does it influence the interest rate?
The Fed earlier announced its fight against serious inflation by raising interest rates and reducing its ballooned balance sheet (which stands at US$9 Trillion). The Fed influences interest rates by 1) changing the Interest of Reserve Balance (IORB) and 2) adjusting RRP rates.
For 1), the Fed sets the upper limit of Fed Funds Rates which pays banks for depositing money on reverse balances. This interest rate is known as the IORB. The IORB guides banks in interest rates adjustments as they borrow money from each other, because banks are unlikely to lend funds in the federal funds market for less than they get paid in their reserve balance account at the Federal Reserve; IORB is an effective tool for setting the upper limit of Fed Funds Rates.
For 2), the Fed changes the award rate of overnight RRP to set the lower limit of the Fed Funds Rates. Many financial institutions do not hold reserves with the Fed and will use RRP to earn interest by depositing funds with the Fed. These institutions are unlikely to lend funds for lower than the RRP rate, thus, the rate of RRP sets the lower limit of the Fed Funds Rate.
When the Fed increases the award rate of RRP, more investment money will be directed towards RRP and such a situation would tend to result in an increase in the amount of RRP. As more money is directed toward RRP, demand for short-term (one month) Treasury Bills should fall, sending its yield higher (Figure 1).
Figure 1: Relationship between RRP award rate(blue) and treasury yield market rate(red)
Source: https://fred.stlouisfed.org
In fact, the Fed has been rolling over RRP since March 2021 (Figure 2).
Figure 2: Fed started RRP in March 2021 amidst inflating its balance sheet.
Source: Huobi Research
It is worth noting that during 2021 to early 2022, while the Fed was still performing Quantitative Easing (QE) and expanding its balance sheet, the amount of RRP rolled over increased cumulatively. With reference to Figure 2, the red area represents the amount of liquidity drained out of the market, derived by deducting net increase of RRP by net increase in Fed balance sheet, since RRP’s introduction. It illustrates that the Fed started draining liquidity out of the market by rolling over RRP since July 2021, when the net difference between the increase of RRP exceeded the increase of the Fed’s balance sheet.
2. Inverted RRP vs SPX, IXIC & BTC
RRP has the opposite impact on the money supply that Quantitative Easing (QE) does. RRP removes money from the money supply in addition to the Federal reserves, whereas QE injects new money to the money supply in additional to bank reserves at the Fed (bank reserves are not included in the money supply). RRP is therefore technically a type of temporary quantitative tightening measure even though its primary intention does not concern the tightening of monetary conditions.
Having explained the effect of RRP, we can now examine its influence on SPX, IXIC and Bitcoin. The following figures show that Inverted RRP is closely related to the prices of SPX, IXIC and Bitcoin. Specifically, when Inverted RRP decreases (amount of rolling RRP increases), there will be more selling pressure posed on the markets. On the other hand, when Inverted RRP increases (releasing deposits back to the counterparties once the agreement matures), the markets would tend to rally due to loosening financial conditions (where more liquidity is injected back to the market).
Figure 3: Inverted RRP (red) acts as a leading indicator to signal Bitcoin, SPX and IXIC price directions
Source: Huobi Research
Figure 3 shows that Inverted RRP, with a leading window of two weeks, has a high correlation to the prices of SPX, IXIC and Bitcoin.
The correlation between Inverted RRP and Bitcoin was observed to be the strongest in the past two months.
Figure 4: BTC and Inverted RRP correlation coefficient at 0.81 (rolling period 12 weeks & 2 weeks offset)
Source: Huobi Research
Figure 5: SPX and Inverted RRP correlation coefficient (rolling period 12 weeks & 2 weeks offset)
Source: Huobi Research
Figure 6: IXIC and Inverted RRP correlation coefficient (rolling period 12 weeks & 2 weeks offset)
Source: Huobi Research
We also see a strong correlation between Inverted RRP and SPX/IXIC that took place in June and July 2022. However, this correlation became weaker in the past two weeks as SPX and IXIC soared while Inverted RRP remained flat. This shows that a flat RRP provided a condition for SPX and IXIC to rise. If Inverted RRP decreases in the near future (or RRP increases), we will expect the correlation to grow stronger, as an increase in RRP will exercise its effect on undermining market strengths of SPX and IXIC.
3. Using Inverted RRP as a leading indicator for Bitcoin sell-offs
The Inverted RRP can be used as a leading indicator for Bitcoin’s trend in the near future. Let’s have a closer look at the current prices of Bitcoin, with respect to Inverted RRP, according to Figure 7. Bitcoin is currently trading in the US$20,000 range. In fact, RRP has been draining liquidity out of the markets since Feb 2022 (an estimated US$700 billion has been absorbed into RRP). A flat Inverted RRP since June means that financial conditions were loosened as RRP stopped draining liquidity out of the markets. This, logically, created breathing space under tight financial conditions. Markets rallied due to short covering, and possibly induced new demand as smart money discovered an opportunity to seize the local bottom.
Figure 7: Inverted RRP acts as a leading indicator to signal Bitcoin sell-offs
Source: Huobi Research
However, the longer term trend for Bitcoin still much relies on macro-economic conditions. The Inverted RRP is only helpful in determining the near trend. It should be used with other liquidity indicators to provide traders with a more complete picture of the current market.
If the Inverted RRP decreases again in the near future (meaning RRP increases, and liquidity is drained out of the markets again), Bitcoin might face more selling pressure. If the Inverted RRP remains flat, or increases (more RRPs reach maturity, releasing liquidity back to the market), we could see an increase in Bitcoin’s price.
About Huobi Research Institute
Huobi Blockchain Application Research Institute (referred to as "Huobi Research Institute") was established in April 2016. Since March 2018, it has been committed to comprehensively expanding the research and exploration of various fields of blockchain. As the research object, the research goal is to accelerate the research and development of blockchain technology, promote the application of blockchain industry, and promote the ecological optimization of the blockchain industry. The main research content includes industry trends, technology paths, application innovations in the blockchain field, Model exploration, etc. Based on the principles of public welfare, rigor and innovation, Huobi Research Institute will carry out extensive and in-depth cooperation with governments, enterprises, universities and other institutions through various forms to build a research platform covering the complete industrial chain of the blockchain. Industry professionals provide a solid theoretical basis and trend judgments to promote the healthy and sustainable development of the entire blockchain industry.
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