Fed’s Balance Sheet Cuts Tighten Liquidity, Stir Repo Market Concerns

The Federal Reserve's ongoing balance sheet reduction is amplifying short-term borrowing costs, draining liquidity from funding markets that have long operated on cheap money. Overnight rates have breached the Fed's target range, signaling strain in the interbank lending system. The reverse repo facility—a key tool for absorbing excess cash—has seen participation drop to a four-year low, reflecting dwindling reserves among money market funds.

Mark Cabana, Bank of America's U.S. rates strategist, warns of a structural shift: "Money funds no longer have excess cash to deploy to the RRP." While a repeat of 2019's repo market crisis isn't anticipated, elevated overnight rates appear persistent. Traders brace for further pressure as upcoming Treasury auctions and corporate tax payments threaten to exacerbate the cash crunch.