Definition of repurchase agreement
A repurchase agreement, or repo for short, is a type of short-term loan much used in the money markets, whereby the seller of a security agrees to buy it back at a specified price and time. The seller pays an interest rate, called the repo rate, when buying back the securities. Example Central banks often use repos to boost money supply, buying Treasury bills or other government paper from commercial banks so the banks can boost their reserves, and selling the paper back at a later date. When the central bank wants to tighten money supply, it sells the paper first, and buys it back later – this is called a reverse repo, an agreement to lend securities rather than funds.
Repo is also short for repossession.
Interactive graphic: how the repo market works
Bloomberg and Financial Times Confusion with Reverse Repos
See the definition at the New York Fed:
The Fed uses repurchase agreements, also called “RPs” or “repos”, to make collateralized loans to primary dealers. In a reverse repo or “RRP”, the Fed borrows money from primary dealers. The typical term of these operations is overnight, but the Fed can conduct these operations with terms out to 65 business days.
Bloomberg called Reverse Repo a liquidity injection; but this is nonsense, the central bank borrows and obtains cash and pays interest on it! As collateral it gives securities. Two more effects are:
- Since the central bank gives bonds as collateral, the supply of government bonds in the market increases and prices fall.
- If the central uses foreign securities as collateral (e.g. the PBOC uses treasuries), then the receiving bank could sell those. Hence the central banks implicitly sells its own currency and the currency must depreciate!
But even Izabella Kaminski has issue with it:
This is because, when you get to the nitty-gritty of it, the initiation of what we’d like to call ‘FARPs‘ is the polar opposite of QE.
In the case of China the relationship between buying and selling of cash inverts.
China’s unprecedented liquidity injection
As we noted earlier, the People’s Bank of China is continuing to inject huge sums of liquidity into the monetary system via so-called “reverse repos” (the equivalent of conventional central bank repos elsewhere). According to China scope, the latest round of easing supplied a record Rmb220bn to the market in exchange for collateral.
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It’s a concept that Also Sprach supports and sums up eloquently here: …when the PBOC tries to prevent Chinese Yuan from depreciating (which is what appears to be happening in the USDCNY pair), PBOC has to buy back Chinese Yuan from the market, i.e. withdrawing money. The action of withdrawing Chinese Yuan by selling foreign assets shrink the foreign reserve and tighten liquidity within China.