Fed Minutes Signal Growing Liquidity Risks Despite Stable Interest Rates

Minutes from the Federal Reserve’s December 2025 policy meeting reveal that officials are closely monitoring a lesser-known but potentially disruptive risk: tightening liquidity in short-term funding markets, even as interest rates remain relatively stable. Released on Dec. 30, the record from the Dec. 9–10 Federal Open Market Committee (FOMC) meeting shows policymakers largely satisfied with the broader economic outlook and market expectations around rates.

According to the minutes, investors had widely anticipated a quarter-point rate cut at the December meeting and expected additional reductions in 2026. As a result, interest rate expectations shifted little during the intermeeting period. However, the discussion went beyond the federal funds rate, focusing instead on signs of stress in overnight lending markets that are essential to the daily functioning of banks and financial institutions.

A central issue highlighted was the declining level of reserves, or cash, in the banking system. While reserves were described as “ample,” Fed officials emphasized that this range can be fragile. Small changes in demand for cash can quickly push up overnight borrowing costs and strain liquidity conditions. The minutes pointed to elevated and volatile overnight repo rates, widening gaps between market rates and the Fed’s administered rates, and increased usage of the Fed’s standing repo facility as warning signals.

Several policymakers noted that these pressures appeared to be building faster than during the Fed’s 2017–2019 balance sheet runoff, underscoring how quickly funding markets can tighten. Seasonal factors are expected to add further strain, including year-end dynamics, late-January adjustments, and a significant springtime drain of reserves as tax payments flow into the Treasury’s account at the Fed.

To prevent reserves from falling below comfortable levels, officials discussed restarting purchases of short-term Treasury securities. These actions would aim to maintain ample reserves and ensure smooth market functioning, not to alter the stance of monetary policy. Survey respondents cited in the minutes expect these purchases to total roughly $220 billion over the first year.

The Fed is also considering changes to strengthen its standing repo facility, including removing usage caps and improving communication so it is seen as a routine liquidity tool rather than an emergency backstop. With the federal funds target range currently at 3.50% to 3.75%, markets are now looking ahead to the Jan. 27–28, 2026 FOMC meeting, where traders largely expect rates to remain unchanged.