What Are Repos and Reverse Repos?

Repos and Reverse Repos: Understanding the Day-to-Day Journey of Money

In financial markets, “Repo” and “Reverse Repo” are the passageways through which vast sums of cash breathe in and out every single day. The terms may sound unfamiliar, but they indirectly influence deposit rates, money market fund (MMF) yields, Treasury yields, and even equity market liquidity. Even a beginner can read the news much more accurately by grasping the basic structure. This post walks through how repos/reverse repos work, why they exist, how they connect to the Federal Reserve (the Fed), and what investors should watch.

What Is a Repo: An Overnight Loan Secured by Collateral

A repo (repurchase agreement) is “short-term funding obtained by pledging collateral with a commitment to buy it back the next day (or on a specified date).” On the surface it looks like “selling a bond today and buying it back tomorrow,” but economically it’s akin to collateralized lending.

Key components

Collateral: Primarily U.S. Treasuries and agency MBS. The safer the collateral, the lower the funding cost.
Haircut: You borrow cash against the collateral after applying a discount to its value. Example: pledge 100 of Treasuries to borrow 98.
Tenor: Typically overnight; sometimes term repo from one week to several months.
Repo rate: The cost of borrowing cash, driven by market liquidity and collateral supply/demand.

A simple example

Dealer A needs $100 million for one day. They pledge$ 102 million of U.S. Treasuries (a 2% haircut) and enter into an overnight repo at 5%. The next day, A repays the $100 million principal plus one day’s interest (about$ 13,888 on a simple 360-day basis) and receives the collateral back.

Repos are the standard way banks, prime brokers, and dealers fund inventories (e.g., Treasuries). Settlement can be bilateral or tri-party (e.g., via BNY Mellon). Recently, sponsored repo via central clearing at the FICC has grown, helping reduce settlement and counterparty risk.

Reverse Repo: The Other Side—Lending Cash and Taking Collateral

“Reverse repo” is the same transaction viewed from the other side. Cash investors (money market funds, corporate treasuries, some institutions) lend cash, take collateral, and earn interest. For the same trade, the cash borrower calls it a “repo,” while the cash lender calls it a “reverse repo.”

What it means for investors

A parking place for safe cash: Deploy cash for very short periods with high credit quality and collateral protection.
Rate floor and yields: Reverse repo rates help set a floor for short-term market rates and anchor MMF yields.
Collateral quality and rates: Higher-quality collateral like Treasuries commands lower rates but offers greater stability.

Repo Rates, SOFR, and How the Fed Implements Policy

Repo market rates sit at the core of the U.S. short-rate complex. In particular, SOFR (Secured Overnight Financing Rate) is the New York Fed’s benchmark for “overnight Treasury-backed repo,” broadly used as the reference rate for dollar derivatives and for loans/bonds.

To “operationalize” its policy-rate target—the federal funds rate (FFR)—the Fed installs a floor and a ceiling in money markets:

IORB (Interest on Reserve Balances): Interest banks earn on reserves held at the Fed, forming a floor for bank rates.
ON RRP (Overnight Reverse Repo Facility): The Fed’s reverse repo window for nonbanks (e.g., MMFs), which provides a broad floor for ultra-short rates. MMFs can invest overnight with “government-level credit plus collateral.”
SRF (Standing Repo Facility): A standing repo backstop where the Fed lends cash against high-quality collateral (primarily Treasuries and agency MBS). It’s designed as a safety valve near the upper end of rates, limiting spikes.

Together, these tools help keep short-term rates within the policy target range. For example, during periods of excess liquidity, usage of ON RRP surged, supporting the floor (from 2021–2023, balances frequently expanded to the trillions of dollars). Conversely, when the Treasury ramped up T-bill issuance and bank reserves declined, reliance on ON RRP fell noticeably (usage shrank markedly in 2024). In September 2019, when cash demand jumped due to tax dates and Treasury settlements, repo rates spiked and the Fed stabilized the market with temporary repo operations—illustrating why the SRF and temporary open market operations matter.

What Actually Matters for Investors

1) MMFs vs. deposit and T-bill yields

MMFs allocate between the ON RRP rate and T-bill yields. When ON RRP provides a floor, MMF yields tend to track it.
When bank deposit rates adjust slowly, MMFs reflect policy rate moves more quickly—this is why they can look relatively attractive.

2) Liquidity in bonds and ETFs

Large bond dealers and ETF market makers fund inventories via repo. Repo stress can spill over into wider bid-ask spreads and higher execution costs.
When a Treasury CUSIP goes “on special” (extreme scarcity), its repo rate trades below the general collateral rate, influencing cash-futures basis trades.

3) Leverage at mortgage REITs and hedge funds

Collateralized leverage strategies are sensitive to rising repo rates and increasing haircuts. A sudden funding squeeze can force rapid deleveraging.

4) Rate outlook and your portfolio

The SOFR forward curve and repo spreads reflect expectations for short-term liquidity. They’re useful signals when adjusting allocations to short-duration assets.

Risks and Common Misconceptions

Repos are “safe” but not “risk-free”

Counterparty risk: Central clearing and tri-party reduce it, but don’t eliminate it.
Collateral price moves and margin calls: When rates jump, collateral values fall, triggering additional margin needs.
Procyclicality of haircuts: In stress, haircuts can widen sharply, forcing deleveraging.
Settlement, month-end, quarter-end: To manage regulatory ratios, repo rates can whipsaw around specific dates.

Fed repo ≠ bailout

The Fed’s repo and reverse repo facilities are collateralized liquidity-management tools. They enforce the policy-rate floor (ON RRP) and ceiling (SRF), distinct from unsecured support.

A Checklist for Interpreting Headlines

Where is SOFR relative to the FFR target range? How far is it from the floor (ON RRP) and the ceiling (SRF)?
ON RRP balance trends: A surge can signal excess liquidity/lack of alternatives; a sharp decline can point to more attractive T-bills or shrinking reserves.
Use of the SRF or temporary repo operations: Rising usage can be a sign of short-term stress.
Treasury issuance calendar: Changes in T-bill supply steer repo and MMF cash flows.
Tax dates, major Treasury settlement days, quarter-end: Watch for increased repo rate volatility.
Treasury “specialness” and the basis: Are specific CUSIPs’ repo rates diverging materially from the average?

Practical Tips for Beginners

For short-term cash management, check government/treasury MMF prospectuses for their ON RRP usage and weighted-average maturity.
If your brokerage sweep rate is low, compare it with MMFs or buying T-bills directly.
When investing in bond ETFs or leveraged products, see how financing costs (the repo rate) flow through to the total cost and to premium/discount behavior.
Around policy events (FOMC), track shifts in SOFR forwards and repo spreads to gauge volatility in short-rate-sensitive assets.

Bottom Line

A repo is the standard short-term funding pipeline—“borrow cash against collateral”—and a reverse repo is its mirror image. Rates and balances in this market are the thermometer of short-term liquidity. The Fed transmits policy to markets through ON RRP (the floor), IORB (the bank-sector floor), and the SRF (the ceiling). Even beginners who understand repo/reverse repo mechanics, the link to SOFR, and the Fed’s toolkit can decode MMF yields, the short end of the bond market, and funding-stress headlines far more clearly. In the end, repos are like a map that lowers the wall of financial complexity: once you understand the flows, you can make more precise decisions on cash management and interest-rate risk across your portfolio.