Liquidity worries creep into Fed minutes as repo usage jumps

Liquidity worries creep into Fed minutes as repo usage jumps.

Summary

• December FOMC minutes show officials worried reserves sit near the lower bound of “ample,” making funding markets vulnerable to shocks.​
• Policymakers weighed T‑bill purchases and a more flexible standing repo facility to avoid a repeat of the 2019-style repo rate spike.​
• Markets still price high odds of steady rates at the Jan. 27–28, 2026 meeting, keeping the funds range at 3.50%–3.75% for now.

Minutes from the Federal Reserve’s December policy meeting revealed concerns about potential liquidity shortages in the financial system, even as interest rates remain relatively stable, according to documents released Dec. 30.

Federal Reserve’s market

The record of the Dec. 9-10 Federal Open Market Committee meeting showed policymakers expressed growing attention to conditions in short-term funding markets, where banks and financial firms borrow and lend cash overnight. Officials noted several indicators pointed to mounting pressure, including elevated and volatile overnight repo rates, widening gaps between market rates and the Fed’s administered rates, and increased usage of the Fed’s standing repo facility, according to the minutes.

Central to the discussion was the level of reserves in the banking system. The minutes stated that reserves had fallen to what the Fed considers “ample” levels. However, several officials emphasized this designation marks a transition zone rather than a buffer, noting that modest fluctuations in demand can push overnight borrowing costs higher and strain funding markets when reserves sit near the lower bound.

Some participants compared current conditions to the Fed’s 2017-2019 balance-sheet runoff, which ended with a sharp spike in repo rates in September 2019. Officials suggested present pressures may be building more quickly than during that earlier episode, according to the minutes.

Staff projections showed that year-end balance-sheet pressures, late-January shifts, and a large springtime drain tied to tax payments flowing into the Treasury’s account at the Fed could significantly reduce reserves, the minutes stated. Without intervention, those flows could push reserve levels below what policymakers consider comfortable, raising the likelihood of disruptions in overnight markets.

To mitigate risks, participants discussed initiating purchases of short-term Treasury securities to maintain ample reserves over time. The minutes emphasized such purchases would support interest-rate control and smooth market functioning, not signal a change in monetary policy stance. Survey respondents cited in the minutes expected these purchases to total roughly $220 billion over the first year.

Officials also explored ways to enhance the effectiveness of the Fed’s standing repo facility, which serves as a liquidity backstop. Participants discussed removing the facility’s overall usage cap and clarifying communications so market participants view it as a routine part of the Fed’s operating framework, according to the minutes.

The federal funds target range currently stands at 3.50% to 3.75%, with policymakers scheduled to convene Jan. 27-28, 2026. As of Jan. 2, the CME Group’s FedWatch Tool showed traders assigning an 85.1% probability to rates holding steady, compared with a 14.9% chance of a quarter-point cut.

Investors had largely expected a quarter-point rate cut at the December meeting and were already pricing in additional reductions in 2026, according to market data. Rate expectations shifted little during the intermeeting period, the minutes showed.

The December minutes showed policymakers broadly comfortable with the macroeconomic backdrop, while highlighting liquidity management as a critical priority alongside interest rate policy.