As the Federal Reserve's December 10 policy meeting approaches, markets are not only focused on the widely anticipated rate cut but also on a potential major balance sheet expansion plan, according to Wall Street strategists.
Former New York Fed repo expert and Bank of America rates strategist Mark Cabana recently predicted that, in addition to the expected 25-basis-point rate cut, Fed Chair Jerome Powell will announce a $45 billion monthly Treasury bill (T-bill) purchase program next Wednesday. The purchases, set to begin in January 2026, aim to inject liquidity into the system and prevent further spikes in repo market rates.
Cabana warned in a report that while markets have reacted calmly to the prospect of rate cuts, investors are largely "underestimating" the Fed's potential balance sheet actions. He noted that current money market rates indicate bank reserves are no longer "ample," requiring the Fed to restart asset purchases to fill the liquidity gap. Similarly, UBS's trading desk predicts the Fed will begin buying about $40 billion in T-bills monthly in early 2026 to stabilize short-term rates.
This potential policy shift comes at a critical juncture as Fed leadership transitions. With Powell's term nearing its end and speculation growing that Kevin Hassett could succeed him, next week's meeting will not only address short-term liquidity but also set the tone for monetary policy in the coming year.
**Monthly $45B Purchases Predicted** While markets widely expect a 25-basis-point rate cut, Cabana believes the real surprise lies in balance sheet policy. In his weekly note titled "Hasset-Backed Securities," he projected the Fed could announce a $45 billion monthly reinvestment program (RMP), far exceeding current market expectations.
Cabana broke down the figure: the Fed needs to buy at least $20 billion monthly to account for natural liability growth, plus an additional $25 billion to offset reserve losses from previous "excessive quantitative tightening." He expects these purchases to last at least six months, with details likely included in the Fed's implementation note and published on the New York Fed's website, focusing on T-bills.
Since peaking at nearly $9 trillion in 2022, the Fed's quantitative tightening (QT) has reduced its balance sheet by about $2.4 trillion, effectively draining liquidity. However, even after QT paused, signs of funding stress persist.
The clearest signals come from the repo market. Key overnight rates like SOFR and TGCR have frequently breached the Fed's policy rate corridor, indicating bank reserves are shifting from "ample" to "adequate," with risks of becoming "scarce." Given the repo market's systemic importance, this threatens monetary policy transmission efficiency.
Recent Fed comments suggest urgency. New York Fed President John Williams said reserves would "soon reach ample levels," while Dallas Fed President Lorie Logan noted it would "soon be appropriate to resume balance sheet growth." Cabana interprets "soon" as referring to December's FOMC meeting.
**Year-End Liquidity Tools** Beyond long-term purchases, Bank of America expects the Fed to announce 1-2-week term repo operations to smooth year-end volatility. Cabana believes these could be priced at or 5 basis points above the standing repo facility (SRF) rate to reduce tail risks.
Regarding administered rates, Cabana sees little chance of an isolated cut to the IOR rate, as banks now prefer higher cash buffers post-SVB. A 5-basis-point cut to both IOR and SRF rates is possible but not his base case.
The meeting also comes amid potential leadership changes, with Kevin Hassett seen as a top contender for Fed chair. Cabana notes markets will increasingly price policy based on the new chair's guidance.
UBS also expects balance sheet expansion, arguing T-bill purchases would shorten the Fed's asset duration to better match Treasury markets. Whether called RMP or QE, the goal remains clear: ensuring smooth market functioning during a critical political and economic transition through direct liquidity injections.
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