FOMC December Meeting Minutes Reveal the Fed's Hidden Concerns About Short-Term Liquidity

The December 2025 meeting minutes of the U.S. Federal Reserve (Fed) just released reveal an important yet rarely highlighted concern: the short-term funding market risks “freezing” due to a lack of cash, even when interest rates are nearly unchanged. The Overall Economic Picture: Relative Stability According to the FOMC meeting minutes held on December 9–10, Fed officials are generally quite satisfied with the current economic environment. Investors at that time were almost certain that the Fed would cut interest rates by 0.25 percentage points, and expected additional rate cuts in 2026. Throughout the period between meetings, expectations for interest rates remained relatively stable. However, the most notable part of the minutes is not about the policy rate, but about deeper concerns regarding the functioning of the financial system behind the scenes. Short-Term Funding Markets Begin to Tighten The Fed is closely monitoring the short-term funding market — where banks and financial institutions borrow overnight cash to facilitate daily transactions. This is the lifeblood of the financial system, and any disruption could quickly spread across the entire market. The focus of this concern is the amount of cash in the banking system, also known as reserves. The minutes indicate that reserves have fallen to a level the Fed calls “adequately abundant.” While this sounds safe, in reality, it is a sensitive zone: even a slight increase in cash demand can cause overnight borrowing costs to spike and pressure liquidity. Early Warning Signs The minutes list a series of signals indicating mounting pressure: High and volatile overnight repo rates Growing gap between market interest rates and the rates set by the Fed Increasing reliance on the Fed’s standing repo facilities Some FOMC members also noted that these pressures are developing faster than during the Fed’s balance sheet runoff in 2017–2019. This raises concerns that the short-term funding market could deteriorate rapidly if the Fed does not act promptly. Timing Factors Increasing Risks In addition to structural factors, seasonal elements also make the Fed particularly cautious. The Fed’s forecasts show: Year-end pressures Significant adjustments at the end of January Especially large cash inflows in spring when tax payments flow into the U.S. Treasury accounts at the Fed These factors could draw a large amount of reserves out of the banking system. Without mitigation measures, reserves risk falling below “comfortable” levels, increasing the likelihood of overnight market disruptions. Fed Considers Proactive Measures To mitigate risks, Fed officials discussed the possibility of purchasing short-term U.S. Treasury bonds to maintain ample reserves in the medium term. The Fed emphasized that this is not a new form of monetary easing, but rather aimed at better interest rate control and ensuring smooth market operation. According to surveys cited in the minutes, the scale of purchases could reach approximately $220 billion in the first year. Simultaneously, the Fed also aims to improve the efficiency of the standing repo facility — a tool providing liquidity during market stress. Proposals include removing the overall usage cap and enhancing communication, so the market perceives this as a normal operational tool rather than an “emergency rescue” signal. Market Awaits the Next Decision Currently, the Fed’s target interest rate range is 3.50%–3.75%. The next FOMC meeting is scheduled for January 27–28, 2026. According to CME Group’s FedWatch tool as of January 1, the market assigns an 85.1% probability that the Fed will hold rates steady, and a 14.9% chance of a further 0.25 percentage point cut. Conclusion The December minutes show that the Fed is not only watching inflation and growth but is also highly alert to silent risks within the financial system. Short-term liquidity, though less noticed, could become a critical weakness if overlooked. The upcoming actions of the Fed are likely to focus on “keeping the money flowing,” even if interest rate policies remain unchanged.