"QT end failed to lift liquidity alert! JP Morgan: the Fed may need to restart the massive injections of capital seen in 2019"

J.P. Morgan strategists said that the Federal Reserve may take additional measures to address pressures in the funding markets, even after ending its balance sheet reduction (quantitative tightening, QT) as early as this week. This pressure may persist even after the Fed stops reducing its $6.6 trillion holdings of U.S. Treasuries and mortgage-backed securities (MBS) this month, according to numerous Wall Street banks including J.P. Morgan. Nevertheless, strategists Jay Barry and Teresa Ho at J.P. Morgan believe that market volatility during key payment periods will continue. In a report to clients on Tuesday, they wrote, "The upcoming conclusion of QT will prevent further liquidity loss in the system, but funding pressures may still persist. Therefore, we believe the Fed might take action similar to what it did in September 2019." At that time, the Fed injected about $500 billion of liquidity into the financial system after short-term interest rates spiked. Although the current market volatility is not as severe as in previous years, J.P. Morgan strategists expect the Fed to implement temporary open market operations to alleviate tension in overnight markets that commonly occur on days of U.S. Treasury settlements, quarter-ends, year-ends, and other key payment dates. They also suggest that the Fed may reduce the rate on its primary liquidity support tool - the Standing Repo Facility (SRF) - which was introduced after market turbulence in 2019 and has seen increased usage in recent weeks. Since the Fed began reducing its asset holdings in June 2022, over $2 trillion has flowed out of the financial system. This has led to a significant decrease in the Fed's main liquidity measure, the Reverse Repurchase Agreement (RRP) balance, while the surge in short-term debt has absorbed more funds. As a result, various lending rates used by banks have risen and remained elevated, even outside of settlement periods. Even the Fed's benchmark interest rate, usually considered less sensitive to liquidity conditions, has risen within its target range, increasing for the fourth consecutive time since the last meeting in September. These signs indicate that banks have not fully redistributed reserves within the financial system after Fed reserve balances fell below $3 trillion earlier this month. Once the Fed stops reducing its Treasury holdings, funds should eventually be reinvested in newly issued Treasuries to rebuild bank reserves. J.P. Morgan's strategists anticipate that the Fed will begin regular Treasury bill purchases in early 2026 as part of reserve management, expecting to buy around $8 billion per month to increase cash in the system. Michael Ball, a strategist at Markets Live, said, "Ending QT will stop the drain on reserves and rebuild the system buffer. Once balances stabilize, repo rates will fall back into the Fed's target range, lowering funding costs. With asset-liability space freed up, traders will be able to reopen relative value trades, enhance liquidity, and suppress cross-asset volatility. Overall, this will provide a better environment for risk appetite." J.P. Morgan strategists also suggest that the Fed should consider lowering the rate on its SRF by 5 basis points in addition to asset purchases. This tool allows eligible institutions to borrow cash against U.S. Treasuries or agency debt. Lowering this rate would help drive down other overnight rates in the repo market - particularly the Secured Overnight Financing Rate (SOFR) and the Tri-Party General Collateral Rate, which have recently risen close to or above the Fed's interest on excess reserves rate. J.P. Morgan strategists believe that this adjustment will encourage market participants to more actively use the SRF, transforming it from a "lender of last resort" similar to a discount window into a more effective tool for managing liquidity and reserves. Regardless of the measures taken, market observers believe that the Fed's work is far from done after ending asset reduction. Lou Crandall, senior economist at Wrightson ICAP, said, "In the not-too-distant future, the Fed will reach a critical point where reserves are no longer 'extremely abundant' and will have to expand its asset size again to maintain balance in the reserve market."