Open Market Operations and Repo Facilities
The FOMC announces a target range for the federal funds rate, but the market determines the actual rate. To keep the effective fed funds rate (EFFR) within the target range, the Federal Reserve uses a set of operational tools: open market operations, repo facilities, and interest on reserves. These mechanisms form a "corridor" that bounds short-term rates. Understanding how they work explains why the Fed can control rates despite not lending directly to banks.
What Open Market Operations Are
Open market operations (OMOs) are the Fed's primary tool for adjusting the supply of reserves in the banking system. The mechanics are straightforward:
To add reserves (ease policy): The Fed buys securities (Treasuries or agency mortgage-backed securities) from banks and dealers. The Fed pays by crediting reserve balances—creating new money electronically. More reserves in the system pushes rates down.
To drain reserves (tighten policy): The Fed sells securities. Banks pay from their reserve balances, reducing the total. Fewer reserves pushes rates up.
Permanent vs. temporary OMOs: Large-scale asset purchases (quantitative easing) are permanent—the Fed holds securities to maturity or sells them later. Repo operations are temporary—the transactions reverse after one day to several weeks.
The point is: OMOs change the quantity of reserves, which affects the price of reserves (the federal funds rate).
Repo: The Fed Lends Cash, Takes Securities as Collateral
In a repurchase agreement (repo), the Fed lends cash to banks and dealers overnight (or for short terms), accepting Treasury or agency securities as collateral. The next day, the dealer repurchases the securities at a slightly higher price—the difference is the interest.
When the Fed uses repo:
- Short-term funding stress (not enough cash in the system)
- Quarter-end or year-end squeezes when banks hoard liquidity
- Emergency situations requiring rapid reserve injection
Standing Repo Facility (SRF): Established in 2021, the SRF provides a permanent backstop. Primary dealers and eligible depository institutions can borrow overnight at a rate set at the top of the target range (currently 4.50%). This rate acts as a ceiling—no bank should pay more than the SRF rate when they can borrow directly from the Fed.
| Facility | Direction | Rate | Function |
|---|---|---|---|
| Standing Repo Facility | Fed lends cash | Top of target range (4.50%) | Rate ceiling |
| Fed Repo Operations | Fed lends cash | Market rates within range | Reserve injection |
Reverse Repo: The Fed Borrows Cash, Lends Securities
In a reverse repurchase agreement (reverse repo or RRP), the Fed borrows cash from counterparties and provides Treasury securities as collateral. This drains reserves from the system.
Overnight Reverse Repo Facility (ON RRP): Money market funds, government-sponsored enterprises, and banks can park excess cash at the Fed overnight. The Fed pays interest (currently 4.25%) and provides Treasury collateral. This rate sets a floor—no institution should accept less than the ON RRP rate when they can lend to the Fed directly.
Why reverse repo matters: When the Fed adds too many reserves through QE, short-term rates can fall below the target range. The ON RRP lets institutions park excess cash at a guaranteed rate, preventing rates from collapsing to zero.
Usage during QE: ON RRP usage peaked at over $2.5 trillion in late 2022 when reserves were extremely abundant. As the Fed has drained reserves through quantitative tightening, usage has declined below $200 billion by late 2024.
| Facility | Direction | Rate | Function |
|---|---|---|---|
| ON RRP Facility | Fed borrows cash | Bottom of target range (4.25%) | Rate floor |
| Reverse Repo Operations | Fed borrows cash | Market rates within range | Reserve drainage |
The Rate Corridor: How the Fed Bounds Short-Term Rates
The Fed maintains a "corridor" system with rates that set the ceiling and floor:
Ceiling: Interest on Reserve Balances (IORB) Banks earn interest on reserves held at the Fed. This rate is set at the top of the target range (currently 4.50%). Banks should not lend reserves at rates below what they can earn risk-free at the Fed. IORB replaced the older term "Interest on Excess Reserves" (IOER) in 2021.
Ceiling backup: Discount Window / Standing Repo Facility Banks can borrow directly from the Fed at the discount rate (typically 50 bps above IORB) or the SRF rate (at the top of the target range). These provide hard ceilings.
Floor: Overnight Reverse Repo Facility Non-bank institutions (money market funds, GSEs) can park cash at the ON RRP rate, set at the bottom of the target range (4.25%). This prevents rates from falling below the floor.
Here is how the corridor looks in practice:
| Rate | Level | Function |
|---|---|---|
| Discount Rate | 4.75% | Emergency borrowing ceiling |
| IORB (top of range) | 4.50% | Banks won't lend below this |
| Effective Fed Funds Rate | 4.33% | Actual market rate |
| ON RRP (bottom of range) | 4.25% | Non-banks won't accept less |
The durable lesson: The fed funds rate floats between the floor and ceiling. The Fed adjusts these administered rates to move the entire corridor up or down.
How These Tools Keep Fed Funds in the Target Range
When the FOMC raises the target range by 25 bps, the Fed simultaneously raises:
- IORB (to 4.50%)
- ON RRP rate (to 4.25%)
- Discount rate (to 4.75%)
This shifts the entire corridor upward. The effective fed funds rate naturally moves higher because:
- Banks demand more to lend reserves (they can earn more at the Fed)
- Money funds demand more to lend cash (they can earn more at ON RRP)
- Borrowers must pay within the new range to attract funds
Why the corridor works: Arbitrage keeps rates bounded. If fed funds traded below 4.25%, money funds would shift to ON RRP. If fed funds traded above 4.50%, banks would borrow from the SRF or discount window. Market forces compress the rate between the boundaries.
Sample Rate Corridor (December 2024)
Here is the current rate structure:
| Rate | Current Level | Spread to Target Midpoint |
|---|---|---|
| Discount Window Primary Credit | 4.75% | +37.5 bps |
| Standing Repo Facility | 4.50% | +12.5 bps |
| IORB | 4.50% | +12.5 bps |
| Target Range Midpoint | 4.375% | 0 bps |
| Effective Fed Funds Rate | 4.33% | -4.5 bps |
| ON RRP Facility | 4.25% | -12.5 bps |
The effective rate typically trades 5-10 bps below IORB because some fed funds lenders (Federal Home Loan Banks, for example) cannot earn IORB directly.
When the Corridor Gets Tested
September 2019 repo spike: The overnight repo rate surged to 10% (normally 2%) due to a confluence of factors: Treasury settlement draining reserves, corporate tax payments, and reduced dealer balance sheet capacity. The Fed responded with emergency repo operations, adding reserves rapidly. This event prompted creation of the Standing Repo Facility.
March 2020 dash for cash: Treasury markets experienced severe dislocations as investors sold securities for cash. The Fed launched massive repo operations and QE to restore functioning. At the crisis peak, the Fed was conducting over $1 trillion in daily repo.
2022-2023 QT period: As the Fed shrank its balance sheet, ON RRP usage declined from $2.5 trillion toward zero. The Fed monitors for signs of reserve scarcity—if the effective rate persistently trades above IORB, reserves may be too tight.
The test: When you see headlines about "money market stress" or "repo rate spikes," the corridor is being tested. Watch whether the Fed responds with facility adjustments or additional operations.
Monitoring the Corridor
Daily data to watch:
- Effective Federal Funds Rate (reported next morning by NY Fed)
- Overnight Repo Rate (SOFR)
- ON RRP usage (reported daily)
- Reserve balances (reported weekly in H.4.1)
Warning signs of stress:
- EFFR consistently at or above IORB
- Repo rates spiking above the target range
- Wide dispersion in money market rates
- Rising discount window borrowing (banks avoid this due to stigma)
Signs of excess reserves:
- EFFR at the bottom of the range
- High ON RRP usage
- Repo rates compressed near the floor
Checklist: Understanding Fed Operations
Essential concepts
- OMOs add or drain reserves to influence rates
- Repo injects cash; reverse repo drains cash
- IORB and ON RRP form ceiling and floor
- The effective rate floats within the corridor
Monitoring workflow
- Check EFFR relative to target range daily
- Note ON RRP usage trends (high = excess reserves)
- Watch for repo rate volatility at quarter-end
- Track reserve balance levels weekly
Your Next Step
Visit the New York Fed's website and check the Effective Federal Funds Rate, ON RRP usage, and SOFR (repo rate) from the past week. Note where each sits relative to the target range. If EFFR is near the top of the range while ON RRP usage is low, reserves are tightening. If EFFR is near the bottom with high ON RRP usage, reserves remain ample. This 5-minute weekly check keeps you ahead of potential money market stress.
Related: How the FOMC Sets the Fed Funds Target | Quantitative Easing vs. Tightening | Standing Overnight Repo and Reverse Repo Facilities