The Federal Reserve's quantitative tightening (QT) program has officially concluded, but recent turbulence in short-term funding markets—including a sharp spike in usage of a key emergency repo facility—suggests liquidity pressures are far from over. Markets are entering a new phase where the Fed will absorb a flood of newly issued Treasury bills while a massive wave of mortgage-backed securities (MBS) hits the market. This complex dynamic leaves the trajectory of overall liquidity highly uncertain.
Under the Fed’s plan, the balance sheet reduction that began in mid-2022 formally ended on December 1. The process had already significantly depleted bank reserve levels, particularly after the resolution of the U.S. debt ceiling impasse in mid-2025, which led to the Treasury General Account (TGA) rebuild and pushed overnight reverse repo (RRP) facility usage near zero, causing reserves to plummet.
Despite the halt in active balance sheet contraction, funding market strains persist. Data shows the Fed’s Standing Repo Facility (SRF) usage hit $26 billion on December 1, the second-highest level since 2020. This signals that even post-QT, systemic liquidity remains scarce, with some traditional market transmission channels still clogged.
The focus has now shifted from QT’s end to the Fed’s next balance sheet strategy. Analysts widely expect the central bank may soon resume asset purchases to prevent further reserve declines and stabilize the financial system. Performance in funding markets over coming months—particularly repo rate volatility—will be key in determining the timing and pace of renewed balance sheet expansion.
**Fed’s New Playbook: From QT to Targeted Bond Buying** With QT over, the Fed’s balance sheet will stabilize in the near term. As previously stated in FOMC meetings, the System Open Market Account (SOMA) portfolio will hold steady at around $6.1 trillion. However, this isn’t static—the Fed will let agency debt and MBS mature naturally, reinvesting proceeds into Treasuries. Goldman Sachs rate strategist William Marshall projects reserves will stabilize near $2.9 trillion by late 2025.
Crucially, Goldman’s baseline forecast expects the Fed to launch a "reserve management purchasing" program in January 2026, buying ~$20 billion in Treasuries monthly while reinvesting ~$20 billion in MBS principal into Treasuries. This aims to absorb liability growth (like cash in circulation) and gradually lift reserves above $3 trillion.
**Reshaped Supply-Demand: Treasuries Gain a Buyer, MBS Faces Pressure** The Fed’s pivot will profoundly reshape bond market dynamics. Under Goldman’s model, the U.S. Treasury is expected to issue $870 billion in net T-bills in 2026, with the Fed absorbing ~$480 billion via reserve management and MBS reinvestment. That leaves just $390 billion for non-Fed buyers—the slowest free-float growth since 2022.
Meanwhile, mortgage markets face heavy supply pressure. Repo expert Scott Skyrm notes that as ~$2.05 trillion in agency debt/MBS from the SOMA portfolio matures and re-enters markets, a "massive collateral reshuffling" will unfold in coming years. This could strain MBS funding and further challenge the already pressured housing sector.
**Funding Strains: Repo Market Stress Persists** Despite QT’s end, secured funding pressures remain sharper than long-term liquidity metrics suggest. Recent weeks saw the tri-party general collateral repo rate (TGCR) and SOFR trade ~6 bps above fair value.
Two theories explain this: 1. A structural rightward shift in reserve demand, implying the Fed may need more aggressive balance sheet expansion to curb short-term funding volatility. 2. A temporary friction as markets adjust to reduced liquidity—consistent with Dallas Fed President Logan’s view that elevated funding costs will push demand back to a lower long-term curve. Forward rates currently favor the latter, anticipating relief post-Q1 next year.
**The Fed’s Next Move & Market Expectations** Markets broadly expect the Fed to ensure sufficient liquidity, anchoring repo rates near the IORB while using SRF to smooth seasonal volatility (e.g., tax periods). Goldman warns latent instability could emerge in coming months (e.g., April tax season), strengthening the case for asset purchases.
Other policy tools appear off the table for now: - Cutting IORB is unlikely, as the effective federal funds rate (EFFR) remains below the corridor ceiling. - SRF rate or clearing mechanism tweaks are improbable barring sustained spillover stress. Ultimately, persistent funding strains will be a key indicator for when—and how aggressively—the Fed resumes balance sheet expansion.