Federal Reserve tightens money market: Shadow banking risks come to light

Introduction: Sudden Tightening Signals in the Currency Market

On October 31, 2025, the eve of Halloween, the U.S. money market experienced significant turbulence. The usage of the Federal Reserve's Standing Repo Facility (SRF) hit a record high of $50.35 billion, far exceeding the levels of the previous weeks. This event is not attributed to seasonal fluctuations but rather signifies a sharp escalation in liquidity pressures within the money market. As the core channel for wholesale financing, the volatility in repo market interest rates and the surge in facility usage have raised concerns about the stability of the overall financial system.

Since mid-September, the money market has shown signs of tightening. On September 15, the Tricolor incident exposed potential risks in the private credit sector, and the quarter-end liquidity window effect intensified the pressure. As October began, the demand for repos continued to rise after mid-month; after the Federal Reserve meeting on October 29, the market briefly calmed down, but it erupted again on October 31. In the morning repo operation, $4.4 billion in U.S. Treasury collateral was borrowed, and nearly $16 billion in mortgage-backed securities (MBS) were borrowed; there was further surge in the afternoon, with Treasury collateral reaching $25 billion and an additional $5 billion in MBS, totaling over $50 billion. This scale has exceeded the Federal Reserve's previous expectations of “technical fluctuations,” similar to the repo crisis in September 2019 when market liquidity shortages forced the Federal Reserve to intervene urgently.

Currently, the Federal Reserve's target range for the federal funds rate is 3.75%-4.00%, following a 25 basis point cut on October 29. However, the Secured Overnight Financing Rate (SOFR) recorded 4.04% on October 30, with a 30-day average of 4.20185%, slightly above the midpoint of the range, indicating that the pressure in the repo market is spilling over to other short-term financing channels. This phenomenon is not isolated but is the result of the accumulation of risk aversion sentiment during the quantitative tightening (QT) process. The Federal Reserve has announced that it will terminate QT on December 1, ending the reduction of the balance sheet ahead of schedule. However, the market questions whether this adjustment is sufficient to resolve the potential crisis.

This article will review the events of 2019, analyze current data, discuss shadow banking and private credit risks, and assess the potential impact on the macroeconomy. Through these aspects, it reveals the systemic challenges behind the tightening of the money market.

Historical Review: Lessons from the 2019 Repo Market Crisis

On September 17, 2019, a sudden liquidity crisis hit the repurchase market in the United States, with the overnight repurchase rate soaring to 10%, far exceeding the federal funds rate ceiling of 5.25%. At that time, the Federal Reserve's balance sheet had shrunk from a peak of $4.5 trillion to about $3.8 trillion, and the QT process led to a decline in bank reserves to $1.4 trillion, causing liquidity to shift from a framework of “ample” to “sufficient,” triggering market friction.

The root of the crisis lies in the accumulation of multiple factors: the end-of-quarter regulatory requirements prompt banks to engage in “window dressing” to reduce leverage exposure; the peak cash demand for corporate tax season; and the risk aversion triggered by global trade frictions leads to a repatriation of overseas dollar funds. The shadow banking system amplifies the pressure, as non-bank financial institutions (such as money market funds) hold a large amount of government bonds but are unable to effectively finance due to a disruption in the collateral reuse chain.

The Federal Reserve responded quickly: on September 17, it launched a temporary repurchase operation, injecting hundreds of billions of dollars in liquidity into the market; starting in October, it expanded asset purchases and restarted the expansion of its balance sheet. The crisis continued until the end of the year, with total intervention exceeding 500 billion dollars. Afterwards, the Federal Reserve introduced the Standing Repo Facility (SRF) and Reverse Repo Facility (RRP) to provide a permanent liquidity buffer. In addition, the reserve framework was adjusted from “ample reserves” to “adequate reserves,” with a target reserve level set at 1.4 trillion to 1.6 trillion dollars.

This event exposed the fragility of the modern financial system: the repurchase market exceeds $4 trillion, accounting for more than 70% of short-term financing, yet it heavily relies on a few large banks (such as JPMorgan Chase and Goldman Sachs). The 2019 crisis, while not causing a recession, accelerated the Federal Reserve's shift to accommodative policies, paving the way for the stimulus amid the pandemic in 2020. The current 2025 scenario is highly similar: QT leads to a decline in reserves, the emergence of shadow banking risks, and global economic uncertainty.

Current Currency Market Data: Signs of Tightening Escalate Rapidly

In October 2025, the usage of repurchase facilities saw exponential growth. In mid-September, the average daily borrowing was less than $1 billion, mainly due to seasonal bottlenecks. At the beginning of October, the quarter-end effect pushed it up to $2 billion, but after mid-month, it stabilized in the range of $700 million to $1 billion. After the Federal Reserve meeting on October 29, usage rose to about $10 billion. However, on October 31, there was an explosive growth: $4.4 billion in Treasury repos and $15.9 billion in MBS in the morning; $25 billion in Treasury and $5 billion in MBS in the afternoon, totaling $50.35 billion, setting a record since the launch of the SRF in 2021.

This surge is not due to the month-end effect. In the money market, the month-end is not a key point, unlike the quarter-end, which involves regulatory reporting. Data shows that on October 31, the balance of reverse repurchase agreements (RRP) reached $51.8 billion, an increase from the previous day, indicating that money market funds (MMF) have saturated their capacity to absorb liquidity. At the same time, the average rate of tri-party repo general collateral (TGCR) was 8-9 basis points lower than the interest on reserve balances (IORB) for the first eight months of October, but turned slightly higher in September-October, indicating an increase in financing costs.

As the benchmark for the repurchase market, SOFR's trend in October is clear: it was 4.31% on October 2, then fell to 4.04% on October 30. The 30-day average SOFR rose from 4.19115% at the beginning of October to 4.20185% at the end of the month, higher than the median of the effective federal funds rate (EFFR) of about 3.875%. The EFFR calculation will be released on Monday, but preliminary estimates suggest that on October 31, it will exceed the upper limit of 4.00%, continuing the volatility pattern seen since September. SOFR in September once exceeded the upper limit by 4 basis points. Although it fell in October, the weekend effect may amplify the pressure.

Bank reserves levels are another focus: averaging $3.2 trillion in the first half of 2025, dropping to $2.8 trillion in October, which is double the peak in 2019. QT has been underway since 2022, reducing $1.5 trillion in assets, but the reserve/GDP ratio still stands at 10-11%, well above the “adequate” threshold. These data indicate that the tightening is not due to an absolute shortage of reserves, but rather to uneven distribution and rising risk premiums.

Federal Reserve Responds: QT Early Termination and Policy Adjustment

The Federal Reserve's response to the current tightening is similar to that of 2019. In the statement from the FOMC meeting on October 29, the committee decided to end QT on December 1, with no further reduction in the total amount of securities held. Chairman Powell acknowledged in the press conference that recent market pressures have accelerated this timeline, similar to the shift in 2019 from “unplanned end” to “emergency intervention.” The Fed has lowered the QT cap from $60 billion per month to $30 billion (mid-2024), but the volatility in October prompted further tightening.

Under the policy framework, the Federal Reserve does not directly target the repo rate but anchors it with the EFFR. However, the SOFR covers 98% of domestic repo transactions and is more representative, with its fluctuations spilling over into the federal funds market. Powell emphasized that this is a normal fluctuation from “ample reserves” to “sufficient reserves,” accompanied by seasonal and regulatory factors. However, market data shows that the October TGCR is higher than the IORB, indicating that financing pressures exceed expectations.

The design of SRF aims to smooth out volatility and provide unlimited borrowing (up to $500 billion daily), but the surge in usage on October 31 shows its buffering effect is limited. The Federal Reserve may discuss additional measures at its November meeting, such as restarting asset purchases or adjusting reserve targets. Analysts expect the end of QT will release about $200 billion in liquidity, but if shadow risks persist, more aggressive intervention may be needed.

Potential Reasons: Risk Aversion and Shadow Banking Risks

The core of the tightening in the money market is not a mistake in the Federal Reserve's policy, but rather an amplification of risk aversion among market participants. The August non-farm payroll report shows a slowdown in the labor market, with the unemployment rate rising to 4.2% and an increase in layoffs among small and medium-sized enterprises. This confirms a downturn in the real economy, impacting the quality of private credit portfolios. The size of the private credit market has reached $2 trillion, with a projected growth of 20% by 2025, but valuation bubbles and fraud risks have become prominent.

Shadow banking (non-bank financial intermediaries) serves as an amplifier of tightening. JPMorgan CEO Jamie Dimon recently warned of “cockroaches,” referring to hidden risks. A typical case is the collapse of Tricolor: this private credit provider defaulted in September, exposing excessive exposure to high-risk auto loans. First Brands followed suit, with a credit rating downgrade in October, leading to a loss of $200 million. These events raised concerns about collateral valuations and caused money market participants (such as MMFs) to reduce repo deployments, even with Treasury guarantees.

The issue of information asymmetry is exacerbating. The Governor of the Bank of England, Bailey, stated in mid-October that he received a “nothing to worry about” response when inquiring with private credit sponsors, but regulators find it difficult to verify. IMF President Georgieva warned that the risks of private credit “keep her awake at night,” as the proportion of loans to banks has risen to 20%. The total scale of shadow banking is $30 trillion, exhibiting “bubble characteristics,” lacking transparency, and may trigger global shocks.

The appreciation of the US dollar exchange rate further increases the US-China interest rate differential, while the return of overseas funds reduces global liquidity supply. In October, the US dollar index rose by 3%, corresponding to SOFR fluctuations. These factors intertwine to create the “cockroach effect”: risks emerge from the shadows, forcing cash holders to turn to Federal Reserve facilities.

Similarities with 2019: Pattern Repetition and Differences

The scenario in 2025 closely resembles that of 2019. First, the QT backgrounds are similar: both occurred during a period of declining reserves, with reserves at 14 trillion in 2019 vs. 28 trillion in 2025, but the relative tightening effects are comparable. Second, the triggering events are similar: in 2019, it was the trade war and yield curve inversion, while in 2025, it will be employment slowdown and private credit defaults. The yield curve inverted in October, signaling recession risks.

The difference lies in the maturity of the tools: the SRF has been operational since 2021, but the usage rate on October 31 shows that it has not fully resolved structural frictions. In addition, the share of private credit is higher in 2025 (shadow banking/GDP 15% vs. 10% in 2019), making risks more systemic. The Federal Reserve's policy is also more cautious: there was an emergency expansion in 2019, while in 2025, it ends gradual responses through QT.

Macroeconomic Impact: From Short-term Volatility to Systemic Risk

In the short term, tightening has increased financing costs, affecting corporate borrowing. Interest rates on loans for small and medium-sized enterprises have risen by 25 basis points, suppressing investment. Although the stock market has not experienced a major shock (the S&P 500 rose 2% in October), the bond spread has widened, and the credit risk premium has risen to 150 basis points.

In the long term, if unresolved, it may trigger a chain reaction: shadow banking defaults affecting bank balance sheets, amplifying credit tightening. The 2019 crisis, although brief, contributed to a 0.5% GDP drag. In 2025, private credit exposure could lead to losses of $1-2 trillion, similar to the early stages of the 2008 subprime mortgage crisis. The global impact is significant: the European Central Bank has been monitoring dollar financing pressures, with potential need for coordinated intervention.

Outlook: November Policy Shift and Risk Monitoring

In the first week of November, EFFR and SOFR data will reveal the weekend effect. If SOFR exceeds the upper limit by 5 basis points, the Federal Reserve may accelerate the end of QT or initiate temporary operations. Market pricing shows a 3.71% probability for the federal funds rate by the end of 2025, implying further rate cuts.

Investors should pay attention to shadow banking regulation: the Federal Reserve and SEC may strengthen disclosure requirements to alleviate information asymmetry. Monitoring the real economy is crucial, as employment and consumption data will determine whether tightening spreads. Overall, current events remind us of the interconnectedness of the financial system: the money market, though invisible, supports global liquidity. Early intervention can prevent a repeat of 2019, but vigilance is needed against the systemic surprises brought by private credit “cockroaches.”