To The Moon

After the Federal Reserve’s October rate cut, dollar market interest rates rose instead of falling, which triggered sharp declines in U.S. Treasuries and equities while the U.S. dollar strengthened significantly. There were two main reasons for the sharp rebound in dollar market rates: first, Chair Jerome Powell’s hawkish comments about a December rate cut, which sharply cooled market expectations for a December cut; second, the prolonged U.S. government “shutdown” tightened dollar liquidity on a temporary basis, prompting panic selling of Treasuries to raise cash.​

Looking ahead, whether the Fed cuts in December depends on when the U.S. government ends the “shutdown” and whether the “catch‑up” employment data deteriorates. The high‑probability scenario is that dollar liquidity pressures will ease as the government reopens, and the odds of a December cut remain significant, with Treasury yields likely to rise first and then fall.​

Government “shutdown” triggers liquidity risk​

Despite the Fed delivering an October rate cut as expected and announcing the end of quantitative tightening in December, funding pressures failed to abate and instead worsened, with dollar market rates continuing to surge and dollar liquidity showing characteristics of a “crisis.”​

Liquidity indicators reflect mounting stress: on November 3, usage of the Fed’s Standing Repo Facility (SRF) reached 1.475 billion dollars, the second‑highest since the facility became permanent, after a record 5.035 billion dollars on October 31. More concerning, the secured overnight financing rate (SOFR) spiked 22 basis points on October 31 to 4.22%, far above the Fed’s 3.9% interest on excess reserves, widening the spread to 32 basis points, the highest since March 2020.​

As of October 31, Fed reserve balances fell to 2.85 trillion dollars, the lowest since early 2021, while foreign commercial banks’ cash assets plunged by more than 300 billion dollars in four months. From a July peak above 1.5 trillion dollars, foreign commercial banks’ cash assets dropped by over 300 billion to 1.173 trillion dollars, funds that were effectively commandeered by the Treasury to cover day‑to‑day expenses during the government shutdown. More critically, the sum of reserves and overnight reverse repo balances has declined to its lowest level since the end of 2020.​

Measured by the ratio of reserves to bank assets, 12%–13% marks the boundary between overly abundant and moderately ample liquidity, while 8%–10% is the warning zone where scarcity begins. During the “cash crunch” of September 2019, this ratio fell as low as 7.94%, forcing the Fed to expand its balance sheet (by purchasing short‑dated Treasuries); currently, the level is 12.2%, right around the “slightly above moderately ample” boundary Powell referenced.​

Money markets also show financing is difficult, with rates rising sharply, and liquidity in the U.S. financial system has fallen to dangerous levels. According to ICAP, on November 3 the overnight general collateral repo rate swung between 4.14% and 4.24%, well above the Fed’s 3.9% rate on excess reserves and even above the 3.75%–4.00% federal funds target range; MBS repo rates were even higher at 4.28%–4.31%.​

The primary driver of tight dollar liquidity is the U.S. government “shutdown,” which requires the Treasury to maintain a high cash buffer and continuously drain liquidity from markets. U.S. financial system liquidity comprises three components—Fed securities/loans, the Treasury General Account (TGA), and the overnight reverse repo facility (ONRRP)—and the difference among them approximates bank reserves. After the debt‑ceiling resolution, the Treasury issued debt to rebuild the TGA; the TGA balance rose from 260.8 billion dollars in June to 983.9 billion dollars by October 29.​

Near‑term Fed cut expectations cool​

At 29 October Eastern Time, following its FOMC meeting, the Fed announced a reduction in the federal funds target range from 4.00%–4.25% to 3.75%–4.00%, a 25‑basis‑point cut. In addition, the Fed announced it would end reductions in its aggregate securities holdings on December 1 and replace maturing MBS with short‑term U.S. Treasuries; effectively, after the runoff stops in December, MBS principal redemptions will be reinvested into short‑term Treasuries, substituting maturing MBS with T‑bills.​

However, two new factors have significantly weakened market expectations for a December cut. First, Fed decision‑makers did not reach unanimity on the rate action: including the newly appointed Governor Milan, “handpicked” by President Trump, two FOMC members voted against the 25‑bp cut; Milan, as in the previous meeting, favored a 50‑bp cut, while Kansas City Fed President Schmid supported holding rates steady, underscoring persistent internal divisions. Second, Powell sent a hawkish signal in the press conference, stating that “a December rate cut is not a foregone conclusion,” and likening cutting to “driving in thick fog—you have to slow down.”​

The near‑term rate path will depend more on a government reopening and the data. The core of the current policy debate is how to balance controlling inflation with addressing the economic slowdown. On one hand, some officials are reluctant to cut too aggressively for fear of overheating the economy and keeping inflation above target; the stock market’s repeated record highs on rate‑cut hopes have also heightened their financial‑stability concerns. If the government “shutdown” ends in November and lagged unemployment data remain stable while economic activity is solid, then a December pause becomes more likely. If the government only “reopens” in December, that will inevitably affect the labor market; once unemployment rebounds above 4.4%, the Fed will continue cutting. In addition, the Treasury would stop draining liquidity and instead release it via the TGA, causing short‑end dollar rates to fall rapidly.​

Moreover, government debt and property‑sector debt issues will both compel the Fed to cut. On the one hand, by benefiting from Fed cuts, the Treasury can refinance at lower benchmark rates and, together with tariff revenues, potentially save the government 1 trillion dollars. On the other hand, as a key barometer of market stress, the delinquency rate on office loans within commercial mortgage‑backed securities (CMBS) has hit an all‑time high; to prevent a repeat of a property‑debt crisis, the Fed, as lender of last resort, will inevitably act.​

In summary, in the short run, the cooling of December cut expectations will dent “easing trades,” and the government “shutdown,” by prompting the Treasury to keep draining liquidity, will tighten conditions, push up dollar funding rates, and drive Treasury yields sharply higher. However, from a medium‑term perspective, a government reopening, debt dynamics, and a weakening labor market will all force the Fed to continue cutting, implying that the rebound in Treasury yields is temporary and the selloff brief. To hedge the short‑term downside risks in Treasuries, investors can consider Treasury futures, such as the CME 10‑year U.S. Treasury futures contract.

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