The $12 trillion short-term financing market (a key source of daily capital for Wall Street) is under pressure, prompting more institutions to call for the Federal Reserve to take stronger measures to alleviate liquidity tightness.

Institutions such as Bank of America, Sumitomo Mitsui Trust Securities, and Barclays Bank have warned that the Federal Reserve may need to take measures, such as increasing lending in the short-term market or directly purchasing securities, to inject funds into the banking system and alleviate market pressures that have pushed up overnight rates.

"Given the recent market pressures, the Federal Reserve seems to be gradually adjusting its balance sheet policy," said Gennadiy Goldberg, head of interest rate strategy at TD Securities, "Some investors believe that the Federal Reserve may be acting too slowly to prevent a reserve shortage."

In recent weeks, a series of key short-term interest rates have remained elevated—from benchmark rates linked to overnight repurchase agreements (loans collateralized by government securities) to the Federal Reserve's own key policy rates (which usually do not change during rate decision periods but have increased within the range four times in the past two months).

Among them, the secured overnight financing rate (SOFR) even experienced its largest single-day volatility since March 2020 (the peak of the pandemic).

Behind the liquidity squeeze is an increase in the issuance of U.S. Treasury securities—this move has siphoned off a substantial amount of cash from the short-term market, leading to a reduction in available funds in the banking system.

The government shutdown that ended late Wednesday local time exacerbated the situation by delaying federal spending that could have boosted liquidity. Meanwhile, the Federal Reserve's ongoing balance sheet reduction (quantitative tightening, QT) has also contributed to the situation.

Even though the Federal Reserve recently announced it would stop reducing its Treasury holdings from December 1, market pressures have not eased. Some individuals fear that the end of the government shutdown stalemate will not entirely resolve the issues.

On Wednesday, Roberto Perli, an official at the New York Fed responsible for the Federal Reserve's securities portfolio, stated that the recent rise in financing costs indicates that reserves in the banking system are no longer ample, and the Federal Reserve will start asset purchases "without much delay." This echoes similar statements made by policymakers in recent days.

A spokesperson for the Federal Reserve Board declined to comment.

For market participants, this signal is well-received. Its core interest lies in the smooth functioning of key financial market mechanisms—cash-rich institutions like money market funds lend short-term funds while investors like hedge funds borrow against high-quality assets like U.S. Treasuries to fund popular strategies such as basis trading.

The market is concerned that a lack of liquidity may trigger volatility, weaken the Federal Reserve's ability to control interest rate policy, and in extreme cases, force investors to liquidate positions, which could affect the U.S. Treasury market—the global benchmark for borrowing costs—while the current economic outlook remains highly uncertain.

For many seasoned market participants, the memories of September 2019 remain vivid. At that time, a key overnight rate surged to 10%, forcing the Federal Reserve to inject $500 billion into the financial system for intervention.

So far, the financing market remains stable, aided by the lending support tools that the Federal Reserve has established in recent years (such as the standing repo facility, SRF, which allows qualified institutions to borrow against U.S. Treasuries and agency securities), which have helped curb significant increases in repo rates and have been frequently used in recent weeks.

Policymakers have also remained cautious during the balance sheet reduction process—in April of this year, given the debate in Congress over the debt ceiling, the Federal Reserve slowed its pace of balance sheet reduction while noting that rebuilding the Treasury's cash balance could exert additional pressure on reserve levels.

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"You could say that the situation in 2019 was somewhat of a disaster," said Zachary Griffiths, head of U.S. investment-grade bonds and macro strategy at CreditSights Inc. "What we have observed recently in the financing market is more of a controllable signal indicating that reserves have essentially fallen to levels suitable for stopping balance sheet reduction."

Although market pressures are generally expected to ease in the coming weeks as the Treasury plans to reduce the scale of weekly Treasury auctions and the Federal Reserve's idle funds will be released after the end of the government shutdown, there remains a risk of volatility at the year-end. Typically, banks reduce their repo market activities before year-end to meet regulatory requirements and improve balance sheet conditions, which could exacerbate turmoil in the financing market at year-end.

Beth Hammack, president of the Cleveland Federal Reserve, stated last week that as reserves continue to approach 'ample' levels (latest data shows the current reserve size is $2.85 trillion), officials are trying to determine an acceptable range of fluctuations.

"I believe that a certain degree of volatility in front-end rates is a good thing, as long as they remain within our policy range," Hammack stated at the New York Economic Club. "For example, a 25 basis point fluctuation, I think, is healthy."

However, Lorie Logan, president of the Dallas Federal Reserve and a former official in the New York Fed's markets department, stated last month that if repo rates continue to rise, the Federal Reserve will need to purchase assets, adding that the scale and timing of purchases should not be mechanical.

For some market participants, the divergence among policymakers regarding the reasonable operating range of the money market and the overall lack of clear guidance is frustrating.

"Where do you want the average level of the money market (interest rates) to be? What constitutes effective control of the money market?" Mark Cabana, head of U.S. interest rate strategy at Bank of America, said, "In our view, it seems unlikely that repo rates will correct themselves to the results the Federal Reserve hopes for."