Increasing Tension in the Night Funding Market: Fed Discusses Structural Changes

Although US interest rate expectations remain stable, a much more concerning issue emerges in the Federal Reserve’s December 2025 minutes: increasing stress in the short-term borrowing markets. According to documents released on December 30th, Fed officials detected signs of stress in the overnight repo market, a situation that is not heavily on investors’ radar.

Signs of a Liquidity Crisis Becoming Apparent

While the banking system appears to have “adequate” reserves on the surface, the situation is not that simple. The critical point emphasized in the minutes is that small demand shocks can rapidly push borrowing costs higher and severely tighten liquidity. The rise in overnight repo rates and the increasing reliance on the Fed’s reverse repo operations serve as a loud warning to the market.

It is clear that seasonal factors could exacerbate this problem. Year-end fund withdrawals and tax accounting could add pressure to the already strained overnight market.

The Fed’s Search for Solutions

To control the risk, the Federal Reserve is considering two main steps. The first is to purchase short-term Treasury securities to ensure banks hold sufficient reserves. The expected volume of these purchases in the first year is around $220 billion.

The second is to strengthen the Fed’s reverse repo facility. The central bank plans to use this tool more effectively to prevent instability in the overnight market. Slightly changing the structure of the US interest rate regime is seen as a way to reduce long-term concerns.

Next Steps

Before the FOMC meeting scheduled for January 27-28, 2026, market participants expect interest rates to remain likely unchanged. However, developments in the overnight funding market could lead the Fed to make small but significant adjustments in its implementation.