Key Highlights

• The Fed appears to be quite comfortable with liquidity conditions.
• RMP sizes have fallen in the last two months; changes in either direction are possible.
• Fed minutes and Waller speech indicate two-sided risk to rates.

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The Fed seems happy with current money market conditions

EXHIBIT #1:  SRP USE GETTING MORE ATTRACTIVE

_{Source: BNY Markets, NY Fed Senior Financial Officer Survey March 2026, Primary Dealer SRP Survey April 2026}

After the Fed surprised us and many others by scaling back Reserve Management Purchases (RMPs) far more sharply than expected – from $25bn to $10bn for the early-May to early-June period (a topic we covered last week) – one might have expected officials to address the surprisingly lower size. SOMA Manager Roberto Perli did just that in a wide-ranging speech last week. He argued that RMPs would be used flexibly to keep reserves at ample levels and to preserve smooth money market functioning. He also acknowledged that the amount of reserves needed by the system might evolve over time in response to market structure, regulation or policymaker preference.

Perli’s appearance coincides with the release of the NY Fed’s Senior Financial Officer Survey (SFOS), which provides considerable evidence that reserve conditions remain comfortably ample. Without reading too much into the Fed’s internal deliberations, the findings of the survey – and the Fed’s more flexible approach to RMPs that Perli lays out –suggest that this month might not be the last time the Fed changes RMPs in meaningful and unexpected ways. In this regime, further reduction in the size of RMPs would be no more surprising than a renewed increase.

Survey respondents generally indicated that they are comfortable with current reserve levels. Half reported no change to their lowest comfortable level of reserves (LCLOR) relative to the prior survey, and most do not expect meaningful changes in those preferences over the next year. Some institutions also expressed a willingness to deploy cash elsewhere if overnight rates rose meaningfully above IORB – hardly the behavior of firms worried about hoarding reserves.

Echoing a recent New York Fed blog post, Perli’s speech also highlighted the growing importance of Standing Repo Operations (SRPs) as a liquidity backstop, noting increased willingness among counterparties to use them when funding pressures arise. The SRPs  were introduced as a backstop, allowing counterparties both to meet their own funding needs and to supply liquidity to the broader market, helping cap upward pressure on repo rates during periods of stress. The open question was always whether firms would actually use the facility, or whether internal approval hurdles, balance sheet costs resulting from the lack of central clearing, or stigma would constrain take-up. Q4 2025 helped address some of those concerns, with the Fed seeing meaningful demand for the first time since Covid: $50bn at end-October, $24bn in November and $75bn at year end.

Perli reinforced the SFOS’s findings, pointing to the system’s greater willingness to use the facility. Banks still require private market rates to move somewhat above the SRP rate before tapping the facility, so it’s not as if SRPs are becoming the first stop for funding. But they do seem to be emerging as a more credible second or third line of defense. The blog cites several reasons for this shift (see Exhibit 1).

Operational improvements, especially the addition of a morning SRP operation, seem to have made the facility more usable for firms managing intraday liquidity needs. The removal of aggregate operation limits also appears to have reassured participants that the facility could handle broad demand if market conditions become strained. Equally important, Fed officials have been more explicit in saying that SRP usage should be viewed as a sensible funding decision, not a sign of weakness. On the flip side, dealers believe the facility would see more usage if the Fed centrally cleared their operations, a view we share.

Shifting the reserve demand curve and bank liquidity regulations

EXHIBIT #2:  SOMA HOLDINGS AS A % OF GDP, PRE-GFC AND PRE-COVID LEVELS

_{Source: BNY, Bloomberg}

Perli meditates on the distinction between a decline in reserves driven by a shift in banks’ underlying demand for reserves (a leftward shift of the reserves demand curve) and one resulting simply from the Fed forcing reserves lower absent any demand shift (a leftward shift along a static demand curve). The latter risks pushing the system onto the steeper part of the reserves demand curve, leading to unpredictably volatile money market conditions. A leftward shift in demand is therefore much more desirable if the goal is to reduce reserves while not upsetting money markets. Perli suggests that one likely catalyst for such a shift is looser liquidity regulation, particularly for U.S. G-SIBs, pointing to the survey suggesting such changes in regulation could reduce their reserve needs.

There is a lot to unpack here for the market and for Chair Kevin Warsh, who continually expresses the preference for a smaller Fed balance sheet. How much he wants to shrink it will help dictate broader balance sheet policy. We are likely to never return to the pre-GFC world, but a pre-Covid balance sheet (as a share of GDP) is definitely achievable (Exhibit 2).

What’s the near-term path? Banks report that they are comfortable with reserve levels at the moment, allowing gradual runoff to proceed. Should it go too far, a flexible strategy of adjusting RMPs allows QT to be quickly reversed. Robust use of SRPs serves as both a warning sign and a shock absorber during active balance sheet runoff and a permanent component of a lower-reserves regime. Finally, and more broadly, a smaller Fed balance sheet will be far easier to sustain if reserve demand itself is structurally lower due to looser liquidity regulations for large banks.

Rates outlook: FOMC moving more hawkish

The recently released minutes of the May FOMC indicate a more hawkish debate than we expected, more so than was indicated by a surprising three dissents regarding the policy orientation of the FOMC statement. Toward the end of the minutes, it was reported that “A majority of participants highlighted, however, that some policy firming would likely become appropriate if inflation were to continue to run persistently above 2 percent. To address this possibility, many participants indicated that they would have preferred removing the language from the post-meeting statement that suggested an easing bias regarding the likely direction of the Committee's future interest rate decisions.”

                              
Fed Governor Waller – an early dissenter in July 2025 citing his concern for the labor market, and who dissented again as recently as January 2026 – argued on the record at an appearance last Friday that rates are just as likely to rise as fall, expressing concerns about short-term inflation expectations bleeding into longer-term ones. 

As readers know, last week we dropped our two-cut outlook for the year and now expect no change in policy unless the Strait of Hormuz reopens relatively soon – sometime in the early- to mid-summer. Having no edge in calling when, if or how that might occur, and seeing little concrete progress toward reopening, we simply could not hold onto our optimistic outlook. However, we wouldn’t be surprised to see rate cuts back on the agenda if oil does start to flow through the Persian Gulf. For now, we split the difference between a scenario where rates could go up or down and remain cautious on any rate moves this year.

Thursday’s PCE inflation report is likely to show – unsurprisingly – accelerating consumer prices, reinforcing the Fed’s hawkish lean. Even with the swearing in of Warsh, a presumed dove, on Friday, we don’t think the Committee in aggregate is likely to offer much support to such a move.

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