Invesco Global Liquidity Monthly

Fed cuts 25bps amid hawkish signals: QT ends as funding pressures mount

25 basis points (bps) expected, hawkish backdrop not expected. The Federal Open Market Committee (FOMC) cut policy rates by 25bps as expected, bringing the target range for the effective federal funds rate (EFFR) to 3.75% - 4.00%.¹ However, dueling dissents by Stephen Miran (50bps cut) and Jeffery Schmid (no change) coupled with Fed Chair Jerome Powell’s post meeting press conference statement that a December rate cut was “far from a foregone conclusion” reset the deck chairs. Expectations for a December rate cut quickly adjusted to a 68% probability from nearly 100%.²

Rate cuts still in the cards. Despite potentially temporary frictions in the Federal Reserve (Fed), we believe the Fed is likely to look past recent inflation as unsustainable and shift its focus to potentially softening employment trends that should keep a December 10th rate cut, and more in 2026, in play.

The end of quantitative tightening (QT) as reserve balances reach lowest level in five years. The FOMC also announced the end of its QT efforts effective on December 1st. At that time, the principal of all maturing agency debt and mortgage-backed securities (MBS) will be reinvested in Treasury bills while maturing Treasury securities will be rolled over. While we believe this debate was in the works for months, recent upward pressure on overnight funding rates pushed the Fed to act to keep reserve balances from declining below their yet undefined “ample reserves” levels. Notably, reserve balances maintained by banking institutions at the Fed are the lowest in five years, but still well above pre-Covid levels.

Upward pressure on funding rates. The secured overnight fund rate (SOFR) and general collateral Treasury tri-party repo rates (TGCR) gravitated upwards at the end of October above the Fed’s upper bound for the EFFR due to Canadian year-end and large coupon settlements while reserve balances drifted lower potentially testing the Fed’s ample reserves regime. Notably, the Fed’s Standing Repo Facility (SRF) hit a record but did not put a lid on funding rates while the Fed’s overnight RRP balances were at the lowest levels in four-plus years. We expect these pressures to subside in November but could resurface around year-end.

Government shutdown, driving without the rearview mirror. We could equate the impact of the government shutdown to driving with the rearview mirror blocked while still having partial visibility via the side view mirrors. Investors and the Fed are doing their best with the information they have in hand. While not complete, other data sources such as corporate announcements, ADP, ISM, S&P, and the Univ. of Michigan can help form opinions, albeit incomplete ones³. With the longest Government shutdown in history just days away, a labor market that has clearly weakened could be the driving force that shapes Fed policy in the near-term.