US Overnight Borrowing Rates Jump Despite Fed’s Move Toward Easing

U.S. overnight funding markets are flashing renewed signs of stress, with the cost of short-term interbank borrowing remaining unusually elevated even after the Federal Reserve adopted a softer policy stance. 

The persistent rise in repo rates is tightening financial conditions across an already fragile market landscape and raising concerns about year-end liquidity.

Traders say the general collateral repo rate, the benchmark cost for borrowing cash against U.S. Treasuries and other high-quality securities, opened Tuesday at 4.05%, five basis points above the upper bound of the Fed’s 3.75%–4% target range. The elevated rate underscores a scarcity of cash in the system and a growing strain in short-term funding channels.

At the end of October, the repo rate surged to 4.25%, a typical month-end spike as banks step back from balance-sheet-intensive activities to meet reporting requirements. Market participants now expect a similar jump as the calendar closes on 2025, a period that historically amplifies liquidity pressures.

Repo rates have traded above the Fed’s 3.90% interest rate on reserve balances since mid-October, indicating that bank reserves are drifting toward levels regulators consider risky. Reserves fell to $2.8 trillion last week, down from $3.3 trillion just months ago,  uncomfortably close to the $2.7 trillion threshold that Fed Governor Christopher Waller deems sufficient to prevent market disruptions.

Joseph Abate, head of interest-rate strategy at SMBC Nikko Securities, warned that overnight funding markets may be more vulnerable today than during the 2019 repo shock, when rates skyrocketed after reserves dropped sharply.

A major factor: hedge funds’ rapidly expanding long positions in Treasury markets through basis and relative-value trades. Abate noted that hedge funds increased their long exposure by roughly $400 billion in the first six months of the year, reaching $2.4 trillion. Their reliance on repo financing has climbed even faster, up $700 billion this year, more than doubling the levels seen in 2019.

These leveraged trades now amount to roughly 7% of the S&P 500’s market value, amplifying the risk of forced unwinds if funding costs spike further.

Analysts say liquidity strains reflect several overlapping shocks. The U.S. Treasury has sharply increased bill issuance to rebuild its cash balance, while a 43-day government shutdown, which ended only last week, created additional distortions.

During the shutdown, halted federal payments led to a buildup of cash in the Treasury General Account (TGA) at the Fed. As new debt settles, banks and money-market funds must pay the Treasury, shifting private-sector cash into the TGA and draining reserves, a dynamic that tightens repo markets.

Scott Skyrm, executive vice president at Curvature Securities, pointed to the ballooning U.S. fiscal deficit as a structural drain on liquidity. A deficit of $1.8 trillion implies roughly $100 billion in fresh Treasury supply each month, requiring continuous financing from investors who depend on repo markets to fund their purchases.

The effective federal funds rate, the Fed’s main policy benchmark, has drifted up to 3.88%, from 3.86% on October 31, despite the central bank’s quarter-point rate cut two days earlier. Analysts say this counterintuitive move is a direct consequence of elevated repo rates pulling broader money-market rates higher.

Market participants warn that prolonged funding pressures could trigger forced deleveraging in riskier asset classes. Stocks and bitcoin have already suffered steep declines in recent weeks, fueling concerns that a liquidity crunch could spill over into broader markets.

The Federal Reserve’s Standing Repo Facility, designed to act as a safety valve during temporary liquidity shortages, remains the system’s final line of defense. But with questions lingering about its ability to absorb a true market-wide shock, investors are bracing for a volatile end to the year.