MW Trouble persists in a key corner of financial markets - and these assets face the greatest risk
By Vivien Lou Chen
'If banks determine that the repo market isn't working, then they might have to resort to liquidating other assets,' such as loans and stocks, should they need to raise cash, one economist says
The Federal Reserve began its efforts to ease pressures in a key corner of the financial market last Friday. But possible signs of pressure persist.
Signs of possible trouble are cropping up again in a crucial corner of financial markets despite the Federal Reserve's best efforts to calm things down last week. It is raising questions about whether the central bank might need to do more to prevent problems from spilling over into the broader financial system.
On Monday, the rate on overnight general collateral repurchase agreements again rose above the Federal Reserve's fed-funds target range, which is now between 3.5% and 3.75%. The overnight GC repo rate is a super-short-term interest rate that big financial institutions pay to borrow cash from other players, such as money-market funds. To some observers, the fact that it has inched up to roughly 3.8% is a sign that short-term funding markets are not yet seeing much of a response to the Fed's move to inject liquidity into the financial system by announcing last Wednesday that it would be buying a total of $40 billion in Treasury bills per month. Those purchases began on Friday.
Short-term funding markets ensure the smooth flow of capital into the economy by providing the behind-the-scenes infrastructure that allows money to flow among major financial institutions. Persistent signs of upward pressure on these interest rates mean that the financial system may be struggling with insufficient access to short-term financing. Rising borrowing costs could lead to potential market disruptions, like what investors experienced in late 2019.
Some market participants are now asking whether the central bank needs to do more to ensure that financial institutions can easily and cheaply secure the money they need ahead of the end of the year, when demand for cash typically spikes.
The Fed purchases announced last week will continue through Jan. 14 and are a way for the central bank to use its balance sheet to reduce pressures in short-term funding markets. As strategists at Morgan Stanley said in a note, "the question is whether the Fed is doing enough or moving fast enough. We will let the market tell us whether the Fed needs to do more by observing how certain assets/spreads trade this week and into year-end."
Funding markets have experienced more pronounced strains over the past few months. Last Friday's initial T-bill purchases by the Fed appeared to go off without a hitch, with funding-market liquidity showing various signs of easing. But that was before the slight bump-up in the overnight GC repo rate on Monday.
"The market is still adapting to a new normal and is still jittery and nervous about how that is going to go," said Derek Tang, an economist at Monetary Policy Analytics in Washington, D.C. "People are very tentative and the jury is still out on whether this will be enough from the Fed. I think the Fed thought it was doing everything and pulling out all the stops. But the market is still nervous."
While there are some year-end factors that are causing financial firms to be less inclined to rely on short-term funding, the risk is that lingering pressures could spread and turn into a "contagion" that results in greater volatility in short-term Treasury bills and other asset classes, Tang said. "If banks determine that the repo market isn't working, then they might have to resort to liquidating other assets (loans, stocks) in a fire sale instead of borrowing in repo if they face a need to raise cash."
Meanwhile, "if the Fed feels its policy rate is not being properly transmitted and if the transmission system doesn't work, then the economy won't get the help that is needed."
Not everyone entirely agrees with the assessments made by Morgan Stanley and Tang.
Sam Zief, global macroeconomic strategist and head of global currency strategy at J.P. Morgan Private Bank, told MarketWatch that there's been "limited reaction in markets and from us" to the start of the Fed's T-bill purchases since they were announced last Wednesday. Still, "I would not be surprised if liquidity conditions remain slightly tight over year-end," he said. "Reserves are not evenly distributed throughout the system," although "money-market conditions should remain well-behaved."
Generally speaking, the central bank's goal is to keep bank reserves sufficient to control short-term interest rates and thereby reduce financial institutions' reliance on the overnight repo market.
Scott Skyrm, executive vice president at Curvature Securities, said the latest rise in overnight rates is the result of a "technical issue" and that there is "nothing out of the ordinary" going on in this part of the market. In his view, the Fed has addressed the liquidity issues for now.
As of Monday afternoon, the broader bond market held relatively steady, with 1-month BX:TMUBMUSD01M through 30-year Treasury yields BX:TMUBMUSD30Y little changed on the day.
-Vivien Lou Chen
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(END) Dow Jones Newswires
December 15, 2025 16:52 ET (21:52 GMT)
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