NEW YORK, October 31, 2025 – The Federal Reserve’s decision to halt its balance sheet runoff and reinvest maturing mortgage-backed securities (MBS) into Treasury bills (T-bills) is expected to ease future supply pressures, but near-term funding strains remain evident in the roughly $4 trillion U.S. overnight repurchase (repo) market.

Despite the Fed’s announcement, repo futures suggest that funding conditions will remain tight through November and December, highlighting persistent liquidity pressures. Analysts estimate that the reinvestment program will purchase about $15 billion in T-bills per month, but immediate relief in short-term funding markets is limited.

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Fed Ends Quantitative Tightening Amid Liquidity Concerns

The Fed cited signs of tightening liquidity that have driven repo rates higher over recent months. Since launching quantitative tightening (QT) in June 2022 to unwind emergency COVID-era stimulus, the Fed’s balance sheet has shrunk from approximately $9 trillion to $6.6 trillion.

By reinvesting MBS proceeds into short-dated T-bills, the Fed is expected to reduce the net supply of bills to private investors in 2026, which could push prices higher, yields lower, and help stabilize overnight funding rates over time.

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SOFR Signals Continued Tightness

Despite the Fed’s T-bill reinvestment, the Secured Overnight Financing Rate (SOFR) remains above the effective federal funds rate, indicating ongoing stress in the repo market.

• SOFR stood at 4.27% on Thursday, while the effective fed funds rate was 4.12%.
• The one-month SOFR-fed funds futures spread, a key liquidity stress indicator, hit minus 11.5 basis points for November and minus 12.5 basis points for December, both historic lows.

These gaps suggest investors expect SOFR to trade above the fed funds rate over the next two months, signaling tight funding conditions despite the Fed’s operational adjustments.

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Analysts Say Fed Could Do More

Market strategists note that while ending QT was anticipated, the Fed did not take additional steps to significantly ease liquidity pressures.

• Jan Nevruzi, U.S. rates strategist at TD Securities, said the Fed could have expanded reserve management purchases by an extra $20–30 billion per month to more aggressively support liquidity.
• Lou Crandall, chief economist at Wrightson ICAP, noted that the Fed is not alarmed by current front-end market conditions and does not see the need for dramatic operational changes.

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Seasonal and Structural Pressures on Repo Markets

Repo rates are currently elevated due to end-of-month and cross-border effects:

• Canadian banks, which are active repo lenders in the U.S., face year-end balance sheet constraints, limiting their capacity to provide liquidity.
• Aggressive Treasury bill issuance following the U.S. debt ceiling increase has heightened repo market demand, requiring more short-term financing to absorb new T-bills.
• Overnight repo rates spike at the end of the month, quarter, or year as primary dealers reduce activity due to higher balance sheet costs.

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Fed’s T-Bill Strategy and Portfolio Neutrality

The Fed’s reinvestment in T-bills was expected by the market. Moving toward a bill-heavy portfolio allows the Fed to:

• Conduct maturity transformation trades, replacing maturing bills with longer-term securities.
• Reduce unintended impacts on term rates while maintaining balance sheet normalization objectives.
• Enhance operational flexibility in money markets.

Currently, T-bills comprise just under 5% of the Fed’s Treasury holdings, leaving room for a portfolio shift that can help smooth short-term interest rate volatility.

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Key Takeaways

• The Fed’s halt of QT and reinvestment of MBS into T-bills will gradually ease Treasury bill supply pressures.
• Near-term repo markets remain tight, with SOFR expected to trade above the fed funds rate in November and December.
• Elevated overnight rates are driven by seasonal funding pressures and aggressive Treasury bill issuance.
• Analysts note the Fed could expand reserve management purchases for additional liquidity support.
• A bill-heavy Fed portfolio enhances operational flexibility and minimizes unintended market impacts.