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In a repurchase agreement (repo), a bank (buyer) temporarily acquires bonds from the Federal Reserve (seller) in exchange for cash. This tool allows the Fed to withdraw money from the economy. Conversely, a reverse repo reverses this transaction: the Fed (buyer) temporarily holds bonds from a bank (seller) in exchange for cash, injecting money into the economy. Currently, the Fed sets the interest rate on reverse repos just below the rate it pays banks on reserves, currently at 4.4%.
These interest rates act as binding price floors, resulting in excess cash within the banking system—money previously printed by the Fed but not being lent to firms or consumers. Banks opt to lend this excess cash back to the Fed, which prints new money to pay them interest. When banks can earn higher, risk-adjusted interest from other investments, they withdraw their cash from the Fed for lending elsewhere. This process can lead to inflation as the previously printed money enters the broader economy. To prevent this, the Fed may raise interest rates on reverse repos and bank reserves, akin to raising a dam's height to control flooding from snow melt in a valley.
Thus, the drop in reverse repo inventory is telling all that inflation is re-accelerating. To stop this, the @federalreserve needs to raise this interest rate and the rate it pays on bank reserves.
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