Federal Reserve’s balance sheet runoff is starting to strain the repo market

Pressure is building inside the Federal Reserve’s funding network as its balance sheet runoff drags on.

According to remarks delivered Thursday by Roberto Perli, who manages the System Open Market Account at the New York Fed, the central bank’s continued effort to unwind its massive securities portfolio is tightening liquidity in the repo market, raising concerns over how short-term interest rates will be managed going forward.

Speaking at an event co-hosted by the New York Fed and Columbia University’s School of International and Public Affairs, Roberto said that as reserves decline from “abundant” to merely “ample,” funding costs in overnight markets are starting to climb. 

He explained that the repo market is already showing signs of stress, and this shift means tools like the Standing Repo Facility (SRF) will now play a more active role in interest rate control.

Fed trims Treasury cap, leaves MBS untouched as liquidity tightens

The Federal Reserve began shrinking its debt holdings in June 2022. But in April 2025, policymakers decided to ease up on how much they let run off. They lowered the monthly cap on maturing Treasuries from $25 billion to $5 billion, but kept the limit for mortgage-backed securities steady at $35 billion.

The adjustment reflects rising sensitivity in short-term markets as liquidity becomes harder to maintain. Despite the tightening trend, cash parked at the Federal Reserve by commercial banks actually climbed to $3.24 trillion for the week ending May 14.

That’s up from $3 trillion the week before, and just slightly below where balances stood when the Fed first launched its quantitative tightening program. Wall Street analysts believe that to avoid systemic liquidity stress, that figure must stay above $3 trillion to $3.25 trillion.

Roberto noted that the rise in repo rates isn’t inherently alarming, saying, “It represents a normalization of liquidity conditions and is not a cause for concern.” But he also admitted the trend will increase the importance of the SRF in the coming months, stating, “In the future the SRF is likely to be more important for rate control than it has been in the recent past.”

SRF faces friction despite renewed role in daily funding

The SRF allows eligible banks and primary dealers to borrow overnight by offering Treasuries and agency debt in exchange for cash. It was designed to give the Federal Reserve more control over short-term rates without flooding markets with excess reserves. But Roberto admitted the facility is far from perfect.

He said, “The more frictionless the facility is, the more effective it will be, and the lower the reserve buffer needed to account for the uncertainty that is inherent in monetary policy implementation.”

To that end, he revealed that the New York Fed plans to make early-settlement operations a permanent feature in its schedule. These additional operations were already tested in December and March, two periods when repo rates typically spike as banks reduce activity to clean up balance sheets for regulatory reasons.

Even so, the SRF hasn’t seen the kind of participation policymakers would like. Roberto pointed to a list of hurdles preventing firms from using it. Dealers are unable to net the transactions off their own balance sheets, and there’s a lack of clarity around how bids are awarded during operations. Both problems make it more expensive and uncertain for participants.

“These frictions add to the costs that counterparties face when using the facility,” Roberto said. “They generally require private market repo rates to trade materially above the SRF minimum bid rate before using the facility.” He emphasized that these issues were especially obvious during the liquidity crunch in December 2024.

The Federal Reserve isn’t walking away from QT just yet, but the funding strain is real, and officials are watching closely. Roberto’s remarks make one thing clear: the central bank’s efforts to shrink its presence in markets will now rely more heavily on technical tools like the SRF — tools that still have some serious kinks to work out.

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