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Concerns over liquidity emerge in Fed minutes as repo usage surges.
Summary
- December FOMC minutes indicate that officials are anxious about reserves being close to the lower limit of “ample,” which may leave funding markets susceptible to shocks.
- Policymakers considered purchasing T-bills and enhancing the flexibility of the standing repo facility to prevent a repeat of the repo rate spike seen in 2019.
- Markets continue to anticipate high chances of steady rates during the January 27–28, 2026 meeting, keeping the funds range at 3.50%–3.75% for the time being.
The minutes from the Federal Reserve’s December policy meeting disclosed worries about potential liquidity shortages within the financial system, even as interest rates remain fairly stable, according to documents made public on December 30.
Federal Reserve’s market outlook
The minutes from the December 9-10 Federal Open Market Committee meeting indicated that policymakers are increasingly focused on the state of short-term funding markets, where banks and financial institutions engage in overnight borrowing and lending. Several indicators were noted, pointing to rising pressure, including volatile and high overnight repo rates, widening discrepancies between market rates and the Fed’s administered rates, and a rise in the use of the Fed’s standing repo facility, as mentioned in the minutes.
A central aspect of the conversation was the level of reserves present in the banking system. The minutes indicated that reserves had dipped to levels the Fed considers “ample.” Nonetheless, several officials stressed that this characterization serves more as a transition zone rather than a cushion, cautioning that minor variations in demand could elevate overnight borrowing costs and exert strain on funding markets when reserves are close to the lower threshold.
Some participants drew parallels between the current situation and the Fed’s balance-sheet reduction from 2017 to 2019, which culminated in a sharp repo rate spike in September 2019. According to the minutes, officials noted that existing pressures might be accumulating more rapidly than during that previous episode.
Staff forecasts revealed that year-end balance-sheet pressures, shifts expected in late January, and a substantial springtime drain related to tax payments flowing into the Treasury’s account at the Fed could considerably deplete reserves, as detailed in the minutes. Without action, these flows could reduce reserve levels below what is deemed acceptable by policymakers, increasing the risk of disruptions in overnight markets.
To address these risks, participants discussed potentially initiating purchases of short-term Treasury securities to ensure reserves remain ample over time. The minutes highlighted that such purchases would assist in interest-rate management and facilitate smooth market operations, rather than signal a shift in monetary policy direction. Survey respondents referenced in the minutes anticipated these purchases to approximate $220 billion in the first year.
Officials also explored methods to enhance the effectiveness of the Fed’s standing repo facility, which acts as a liquidity safety net. Participants considered abolishing the facility’s overall usage cap and improving communications to ensure market participants regard it as a standard component of the Fed’s operating framework, according to the minutes.
The federal funds target range is currently set at 3.50% to 3.75%, with policymakers slated to meet on January 27-28, 2026. As of January 2, the CME Group’s FedWatch Tool indicated traders assigning an 85.1% probability to rates remaining unchanged, juxtaposed with a 14.9% likelihood of a quarter-point reduction.
Investors largely anticipated a quarter-point rate cut at the December meeting and were already factoring in additional reductions for 2026, per market data. Expectations for rates showed little change during the intermeeting period, as indicated in the minutes.
The December minutes reveal that policymakers felt broadly at ease with the macroeconomic landscape while underscoring the importance of liquidity management as a key priority alongside interest rate policy.
