Concerns about hidden stress in U.S. funding markets are starting to surface, even as interest rates remain unchanged. Minutes from the December meeting of the Federal Reserve show policymakers growing uneasy about liquidity conditions, with particular attention on rising activity in overnight repo markets.
The record of the Dec. 9–10 Federal Open Market Committee meeting, released on Dec. 30, revealed that officials are increasingly focused on short-term funding dynamics. Several indicators suggest pressure is building, including volatile repo rates, wider gaps between market rates and the Fed’s administered rates, and heavier use of the central bank’s standing repo facility.
Reserves near the lower edge of “ample”
At the center of the discussion was the level of bank reserves in the financial system. Policymakers noted that reserves have declined to what the Fed defines as “ample,” but several participants stressed that this level represents a transition zone rather than a comfortable buffer.
When reserves sit near the lower bound, even modest shifts in demand can lead to sharp increases in overnight borrowing costs. Officials warned that such conditions make funding markets more sensitive to shocks and increase the risk of disruptions.
Some participants drew parallels to the Fed’s 2017–2019 balance-sheet runoff, which culminated in a sudden spike in repo rates in September 2019. According to the minutes, several officials believe current pressures may be building faster than they did ahead of that episode.
Seasonal drains add to the risk
Staff projections cited in the minutes pointed to several upcoming drains on liquidity. Year-end balance-sheet pressures, late-January settlement dynamics, and a significant spring drawdown tied to tax payments flowing into the Treasury’s account at the Fed could all reduce reserve levels further.
Without action, those factors could push reserves below what policymakers view as comfortable, increasing the likelihood of stress in overnight funding markets.
Possible tools on the table
To reduce those risks, officials discussed restarting purchases of short-term Treasury bills. The minutes emphasized that such purchases would be aimed at maintaining ample reserves and preserving control over interest rates, not signaling a shift in the broader monetary policy stance.
Survey respondents cited in the minutes estimated that T-bill purchases could total around $220 billion over the first year if implemented.
Policymakers also considered adjustments to the Fed’s standing repo facility, which acts as a liquidity backstop. Ideas included removing the overall usage cap and improving communication so market participants see the facility as a routine part of the Fed’s operating framework rather than an emergency tool.
Rates expected to stay put for now
Despite the liquidity discussion, interest-rate expectations remain largely unchanged. The federal funds target range currently sits at 3.50% to 3.75%, with the next policy meeting scheduled for Jan. 27–28, 2026.
As of Jan. 2, data from the CME Group FedWatch Tool showed markets assigning an 85.1% probability that rates will remain steady, compared with a 14.9% chance of a quarter-point cut.
Investors had previously anticipated a rate cut at the December meeting and continue to price in gradual easing later in 2026. The December minutes suggest that while policymakers are broadly comfortable with the macroeconomic outlook, liquidity management is emerging as a priority alongside rate policy.
