The United States is heading towards a "liquidity crisis," and a "government shutdown" is equivalent to an interest rate hike? The next step is crucial for the market.

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The United States is facing an increasingly severe liquidity crisis. Despite the Federal Reserve's announcement of ending QT, funding pressures have not eased but have continued to worsen. Behind this, the U.S. government shutdown is draining market liquidity, with an effect comparable to several rate hikes and also setting the stage for a rebound in risk assets at year-end.

Key financing indicators show that market pressure has reached a critical point. This Monday, usage of the Federal Reserve’s Standing Repo Facility (SRF) reached $1.475 billion, the second highest since the facility was made permanent, after last Friday’s record of $5.035 billion.

More worrying still, the Secured Overnight Financing Rate (SOFR) jumped 22 basis points to 4.22% on October 31, far above the Fed’s excess reserves rate of 3.9%. The spread widened to 32 basis points, the highest since March 2020.

This indicates that although the Fed cut rates last week, the market’s actual financing costs are as if there was no cut at all. The root cause of liquidity strain is the government shutdown, which forced the Treasury to increase its cash balance from $300 billion to $1 trillion over the last three months, sucking liquidity from the market. Fed reserves have fallen to $2.85 trillion, the lowest since early 2021, while foreign commercial bank cash assets have plummeted by more than $300 billion in four months.

However, crises also present opportunities. Goldman Sachs and Citigroup expect the government shutdown could end within two weeks. Once the government reopens, the Treasury will release hundreds of billions of dollars into the market, and this “invisible quantitative easing” could spark a massive rush into risk assets, pushing equities sharply higher at year end.

All Liquidity Indicators Flash Red

Multiple key money market indicators show U.S. financial system liquidity has dropped to dangerous levels. Although the market generally expected stabilization after month-end—banks typically "dress up" their books and absorb liquidity at month-end—this normalization has not occurred.

Last Friday, the general collateral repo rate spread (vs. the excess reserves rate) in the tri-party repo market surged to 25 basis points, again hitting a pandemic-era high. According to ICAP data, overnight general collateral repo rates ranged violently from 4.14% to 4.24% this Monday, far above the Fed’s 3.9% excess reserve rate and even exceeding the 3.75%–4.00% fed funds target range. MBS repo rates were even higher, at 4.28%–4.31%.

The market had expected that after month-end, Canadian year-end settlement, and Treasury auction settlements, financing costs would normalize. But early Monday data shows rates remain abnormally high even after these seasonal factors have faded, indicating liquidity strain is not just technical.

Fed reserves have dropped to $2.85 trillion, the lowest since early 2021. More critically, the combined total of reserves and reverse repo balances has fallen to its lowest since the end of 2020.

Over the past three years, the reverse repo tool has acted as an "excess liquidity reservoir," but its balance now stands at just $51 billion, meaning all future repo needs must be met via the Standing Repo Facility, putting further strain on funding conditions.

Government Shutdown Drains Liquidity, Equivalent to Stealth Rate Hike

The ongoing government shutdown is now the main driver for monetary market liquidity depletion. The U.S. Treasury General Account (TGA) balance has surged sharply.

As of last Friday, the TGA balance had topped $1 trillion for the first time since April 2021, a nearly five-year high. This means the Treasury has pulled more than $700 billion in cash from the market over the past three months—soaring from about $300 billion in July to the current level.

This massive Treasury cash absorption has directly caused a liquidity drought in the market. According to Fed H.8 data, foreign commercial banks have been the hardest hit, with their cash assets plunging by over $300 billion from a July peak of more than $1.5 trillion to $1.173 trillion. In essence, these funds have been commandeered by the Treasury to sustain daily spending during the shutdown.

This situation has produced an unexpected result: The Treasury has in effect become the de facto monetary policy setter, as its fiscal operations are dictating monetary conditions. It could be argued that, if not for the TGA rising from $300 billion to $1 trillion in three months, the Fed might not have ended quantitative tightening.

Analysts believe, in effect, the government shutdown is equivalent to several rounds of rate hikes, as the $700 billion in liquidity withdrawn rivals tightening from marked monetary policy tightening. The Fed was still doing QT in November, which further worsened an already fragile funding landscape, making its decision to delay ending QT until December potentially another policy blunder.

BofA liquidity experts Mark Cabana and Katie Craig have called for the Fed to consider buying Treasuries or launching regular open-market operations up to $500 billion to replenish bank reserves. The worsening funding conditions show a dangerous self-reinforcing pattern. If key indicators continue to deteriorate, we may see feedback loops akin to the repo crisis of September 2019 or the March 2020 basis trade crash.

Reopening May Trigger Sharp Rally in Risk Assets

Despite grim short-term prospects, the very root of the crisis is also the turning point. Since the government shutdown is the main driver of tight liquidity, once it ends, the Treasury will begin drawing down its massive TGA cash balance, releasing hundreds of billions of liquidity into the economy.

This liquidity release may trigger a massive rush into risk assets. A similar scenario played out in early 2021, when rapid TGA drawdowns acted as “invisible QE,” fueling a sharp stock market rally. This playbook may repeat in 2025–2026.

Once the government reopens, the release of pent-up liquidity will coincide with year-end, potentially triggering explosive rallies in liquidity-sensitive assets like Bitcoin, small caps, and virtually all non-AI assets. The worse the current situation, the more reserve liquidity will be released mid-term.

However, this is not a long-term solution. America’s enormous budget deficit means funding conditions will worsen again, and at that point the Fed will have to intervene—as BofA’s Mark Cabana predicts, possibly with genuine asset purchases. For now, the fate of risk assets depends on the government’s reopening timeline.

Shutdown May End within Two Weeks?

Goldman Sachs expects the government shutdown is most likely to end around the second week of November. Key pressure points include pay for air traffic controllers and airport security staff due on October 28 and November 10—similar interruptions in 2019 ultimately brought that shutdown to a close.

Goldman lists several reopening paths: a few Democratic senators may switch sides and vote to extend funding to November 21; more likely is a compromise where Democrats agree to pass the resolution in exchange for a Republican promise to hold a vote on extending Medicaid subsidies after reopening; a third and less likely option is that Republicans drop the filibuster to pass the resolution by simple majority.

Prediction markets put the chance of reopening before mid-November at about 50%, with less than a 20% chance of dragging past Thanksgiving. Citigroup is "increasingly confident" the shutdown will end within the next two weeks. Once the government reopens, data releases will resume quickly, and the Federal Reserve could have up to three jobs reports before its December meeting, providing more basis for continued rate cuts.

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