A new wave of pressure for the U.S. money market? Wall Street warns: The Fed may be forced to restart asset purchases.

Financing pressure in the U.S. money market is triggering growing concerns on Wall Street. Several major investment banks have warned that sustained funding stress may force the Federal Reserve to act more swiftly, possibly even restarting its long-dormant asset purchase program.

The gap between key market rates and the Fed's target rate reached its highest level since 2020 last Friday. Although the triparty repo rate fell back somewhat this Wednesday, market participants generally see this as only a temporary respite. Deirdre Dunn, Citi’s Head of Rates Trading and Chair of the Treasury Borrowing Advisory Committee, said this is not a one-off anomaly caused by a few days of volatility. Meanwhile, Barclays U.S. Rates Strategist Samuel Earl also noted that the funding market is "not out of the woods yet".

Wall Street analysts point out that three years of quantitative tightening combined with record U.S. Treasury issuance are pushing bank system reserves into dangerous territory. Citi’s Dunn noted that the market may no longer be operating in an environment of ample reserves. Barclays also pointed out that, while some short-term positive factors (decline in TGA and reduced Treasury issuance) are supportive, liquidity at year-end is still "riddled with hidden dangers."

Analysts widely believe that sustained funding pressures could force the central bank to expand its balance sheet again, ending three years of quantitative tightening. Dallas Fed President Lorie Logan stated clearly last week that if the rise in repo rates proves not to be temporary, the Fed may need to start buying assets. This statement highlights the degree of concern in decision-making circles over market pressures.

Funding Pressure Eases For Now But “Not Out of the Woods”

After signs of stress in key parts of the financial system at the end of last month, short-term borrowing rates have stabilized this week. The spread between triparty repo rates and the Fed's interest rate on reserve balances narrowed during the week, and some of the pressure in money markets has eased. However, market participants remain on alert.

Scott Skyrm, Executive Vice President of repo market specialist Curvature Securities, said that while the market has "returned to normal" — in part because banks used Fed tools to relieve money market stress — "financing pressure will at least reappear at the end of next month and at year-end."

In its latest report, Barclays said that recent funding stress is mainly due to two major factors: massive short-term Treasury (T-bill) issuance and continued growth in borrowing demand from leveraged investors.

The large volume of Treasury issuance in October pushed the Treasury General Account (TGA) balance up to $1 trillion on October 30, well above the Treasury's $850 billion target for quarter-end.

This process drained a large amount of liquidity from the banking system, causing reserve balances to fall to around $2.8 trillion at month-end. Against this backdrop, coupled with Canadian banks withdrawing funds from the U.S. repo market due to their fiscal year-end, it’s no surprise that end-of-month funding stress intensified.

The bank noted that at the end of October repo rates surged again, occurring just as the Fed, due to rising funding pressure, decided weeks earlier to end QT ahead of schedule. Although the Secured Overnight Financing Rate (SOFR) dropped back into the Fed's target range after month end, temporarily easing market jitters, a core question faces investors again: Has the Fed pushed bank system reserve levels too low?

Many analysts believe that after three years of quantitative tightening, the Fed is close to the limit for extracting cash from the financial system. When this happens, banks’ reserves could fall into dangerous territory. Citi’s Dunn said:

“You could say we are no longer in an environment of ample reserves, and these events may keep recurring.”

Short-term Positives: TGA Decline and Reduced Treasury Issuance Will Inject Liquidity

However, according to the Barclays report, despite persistent risks, the bank identified two positive factors that may help ease funding pressure by the end of the year.

First, the TGA account balance has peaked.

Barclays expects that $1 trillion is the “high water mark” for the TGA balance. As the Treasury plans to reduce its cash balance to $850 billion by year-end, about $150 billion of reserves should flow back from the TGA into the banking system.

The report also assessed the impact of a government shutdown, concluding that its effect on TGA balances would be relatively small—at most about $25 billion per month, which is negligible compared to the huge reserves and overall account sizes.

Second, the peak period of short-term Treasury issuance has also passed.

To achieve the $850 billion cash target, net Treasury issuance for the rest of the year will be minimal. More specifically, there will still be net issuance in November, but December will see large net redemptions. According to signals from the Treasury at its Q4 refunding meeting, net redemptions of Treasury securities in December will be between $100 and $120 billion, providing an important “tailwind” for year-end liquidity.

Potential Risks Remain: Year-end Liquidity "Riddled with Hidden Dangers"

Despite short-term relief factors, Barclays also stressed that some structural pressures will continue to threaten money markets in the fourth quarter.

Traditionally, Q4 is a period of heightened funding stress, as global systemically important banks (GSIBs) proactively shrink their balance sheets to manage their systemic risk scores.

Additionally, with this year’s elevated stock prices, equity repo operations will mechanistically consume more of the already limited balance sheet capacity of banks. All these risks are happening while reserve levels are already on the low side, making year-end liquidity more fragile.

More worrying is that a key instrument used by the Fed to cap rates—the Standing Repo Facility (SRF)—is losing effectiveness. The SRF is meant to provide liquidity to the market and keep repo rates below its set cap.

However, for several days over the past week, the triparty general collateral repo rate (TGCR), which represents the rate at which money market funds lend, has repeatedly risen above the SRF rate.

This means dealers would rather borrow from money market funds at a higher cost than use the Fed’s SRF.

Dallas Fed President Logan has publicly expressed disappointment about this. Barclays points out that there are implicit costs—balance-sheet, stigma, and relationship management—for borrowing from the Fed. Compared to the 2019-2020 cycle, borrowers are even less willing to borrow from the Fed this time.

Samuel Earl said in the report that if the TGCR continues to significantly breach the SRF rate, it would be the clearest sign of the tool’s ineffectiveness and could prompt the Fed to act to strengthen it, especially via a central clearing mechanism.

Will the Fed Be Forced to Restart Asset Purchases?

Some analysts and policymakers say that if stress doesn’t ease, the Fed may need to start buying assets directly.

Former New York Fed Markets Group staffer and current Dallas Fed President Logan noted last week that if the recent rise in repo rates isn’t temporary, she believes the Fed will need to start buying assets.

BofA rates strategist Swiber said:

"An aggressive pace of Treasury issuance is historically very high, posing the risk of sapping traditional investor demand for Treasuries. To better balance Treasury supply and demand, we believe a long-dormant buyer may be needed: the Fed."

Barclays, however, believes that while the Fed is closely watching repo pressures, immediate intervention is unlikely.

On one hand, there are “hawks” on the committee reluctant to expand the balance sheet and are disinclined to “bail out” the repo market too quickly. On the other, if the Fed were to buy Treasuries immediately in response to volatility caused by issuance, it would look a lot like “fiscal dominance”—something the Fed is keen to avoid.

Nevertheless, the repo market is a key driver for the direction of the federal funds rate. So if repo rates persist at the top or above the target range, the Fed will eventually have to act. Barclays expects that if high rates continue for several more weeks, the Fed may make adjustments.

If so, the Fed’s first step would be to strengthen the SRF, for example via introducing central clearing, lowering the SRF rate, or offering term repo operations to smooth across year-end funding pressure.

The report’s baseline forecast is that the Fed won’t need to expand its balance sheet to add reserves until next year. But if the situation seriously worsens, it may roll out repo operations and outright Treasury purchases (RMPs) at the same time to quickly relieve market strain.

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