US liquidity shortage and intensified repo market pressure

Financial Market Storm Resurfaces

On an ordinary Friday, October 17, 2025, global financial markets were shrouded in a haze. Liquidity shortages were becoming increasingly severe, with pressure in the repo market escalating and the SOFR (Secured Overnight Financing Rate) spread reaching a new high since 2019. Meanwhile, bank stocks, especially those of regional banks, suffered a sharp drop, sparking market concerns about potential credit events. This isn't just a problem for isolated banks; it signals a liquidity crunch across the entire financial system.

The current market environment is reminiscent of the 2019 repo market crisis and the 2023 regional banking crisis. Back then, a liquidity shortage caused short-term funding costs to soar, exposing the banking system's vulnerabilities. Similar signs are resurfacing today: the weekly spread between SOFR and reverse repo has reached its highest level since July 2019, with SOFR even exceeding the Federal Reserve's discount window rate by 5 basis points. This suggests that the shift from excess to shortage of US dollar liquidity has become a reality. The plunge in bank stocks, particularly regional banks like Zions Bancorporation and Western Alliance Bancorporation, has further exacerbated these concerns. Their share prices have collapsed, with their largest single-day declines since the regional banking crisis of 2023. I. Turbulence in the Banking Sector – Is the Regional Banking Crisis Resurfacing? Recent data suggests that the banking sector is experiencing significant volatility, marking the beginning of this market turmoil. Regional banks are often more vulnerable to economic downturns due to their heavy reliance on commercial and industrial loans, consumer loans, and commercial real estate (CRE) exposure. Take Zions Bancorporation, for example. Zions Bancorporation, a Utah-based bank with a core business in commercial and industrial lending, recently disclosed a $50 million write-off on two suspected fraudulent loans and filed a lawsuit to recover $60 million. Broader concerns arise regarding challenges with consumer lending and CRE exposure. As we all know, the commercial real estate market has been weakening since 2020. High interest rates have led to rising vacancy rates and declining rental income for office and retail properties. Zions' stock price plummeted in a single day, the largest drop since the regional banking crisis of 2023. This case is not limited to an isolated incident, but rather reflects the vulnerability of the entire industry. Phoenix-based Western Alliance Bancorporation faces similar difficulties. The bank is highly dependent on non-depository financing institution (NDFI) loans and is exposed to the automotive and consumer sectors. Weak consumption among low-income groups (the lower end of the K-economy) has directly impacted the quality of these loans. The bank recently disclosed fraud allegations against borrowers involving First Brands and Ricoh, and filed lawsuits totaling over $100 million. While the bank maintained its 2025 outlook, its NDFI loan portfolio is facing scrutiny due to rising non-performing loans. The difficulties faced by these two banks are not accidental, but rather a product of growing economic divergence: high-income groups benefit from rising asset prices, while lower-income groups suffer from inflation and unemployment. The turmoil at regional banks has begun to spread to larger banks. Data from October 16th showed that Citigroup fell 3.5%, Capital One Financial Corporation fell 5.5%, Goldman Sachs fell 1.3%, and JPMorgan Chase fell 2.3%. While large banks have higher capital ratios, they are not immune. Institutions like Capital One focus on low-credit-score loans, making them vulnerable to consumer defaults, similar to regional banks. The KRE (Regional Bank ETF) experienced its largest single-day drop since 2023, second only to "Liberation Day" in April 2023. To quantify this risk, credit spreads can be used. The ratio of LQD (investment-grade corporate bond ETF) to HYG (high-yield corporate bond ETF) is a useful proxy for high-frequency monitoring of credit spreads. A rising ratio indicates a greater preference for investment-grade bonds relative to high-yield bonds, reflecting increased credit risk. The true benchmark is the BofA High Yield Option-Adjusted Index, but it is updated less frequently daily. Currently, the LQD/HYG ratio indicates widening credit spreads, suggesting that bad debt write-offs could impact bank profitability and solvency. Even more concerning is the regional banks' connection to private credit. The private credit market has surpassed a trillion dollars, and many regional banks participate in it through loans or investments. If bad debts spread contagiously, it could trigger a chain reaction. JPMorgan Chase CEO Jamie Dimon called it a "cockroach problem," meaning that one bad debt often signals more hidden problems. This isn't limited to banks; it could also ripple through the broader equity market. As a result, S&P 500 futures plummeted in early trading. While they have since rebounded, this suggests a wavering market confidence. Looking back, the regional banking crisis of 2023 (the collapse of Silicon Valley Bank, Signature Bank, and First Republic) stemmed from bond losses and deposit outflows caused by rising interest rates. Today, with the continued high interest rate environment and intensified liquidity constraints, similar risks are resurfacing. Consequently, the stock prices of KRE, Zions, and Western Alliance, as well as credit spreads, are attracting considerable attention. If bad debts continue to surface, the stability of the banking system will be tested. 2. Repo Market Pressure Intensifies – SOFR Spread Hits Record High The repo market is the core battleground for liquidity shortages. Repurchase agreements (repos) are short-term financing instruments used by banks and institutions to borrow funds against collateralized securities (such as U.S. Treasuries or mortgage-backed securities). SOFR is the benchmark for repo rates, reflecting the cost of overnight secured funding. This week, the weekly spread between SOFR and reverse repos reached its highest level since July 2019, just 1 basis point higher than last week, but the trend is clear: liquidity is shifting from ample to scarce. SOFR has exceeded the Fed's discount window rate by 5 basis points, a rare occurrence typically seen only at quarter-end or year-end. However, these are not the times, and there are no tax deadlines or window dressing factors at play. On October 16, the Federal Reserve's Standing Repo Facility (SRF) saw $8.35 billion in draws, signaling the activation of its emergency backstop. The SRF allows institutions to borrow against Treasury bonds or mortgage-backed securities (MBS). Notably, MBS accounted for a higher proportion of SRF draws than Treasury bonds. This may indicate weakness in the MBS market, similar to the liquidity crisis during the 2020 pandemic. To make this shift easier to spot, examine the difference between reverse repos and the SRF. This indicator has turned negative for the first time since 2020. Reverse repos act as a "storage tank," storing excess dollars; the SRF acts as an "emergency spigot," providing scarce dollars. A negative difference indicates a shift from a surplus to a shortage. The Federal Reserve attempts to control the repo market through an interest rate corridor: the discount window rate (4.25%) serves as an upper bound, and the reverse repo reward rate (4%) serves as a lower bound. Currently, as in late 2020 and 2024, the difference between SOFR and the federal funds rate (Fed Funds) is surging on the daily chart. However, SOFR has breached its upper bound, indicating an imbalance between supply and demand in the market. Repo market crises are nothing new. In September 2019, repo rates soared to 10%, prompting the Federal Reserve to intervene quickly, injecting reserves through the purchase of Treasury bonds and MBS. The 2019 crisis cannot even be captured on a weekly chart due to its brevity and the Fed's swift response. Today, if the pressure persists, the Fed could resume similar operations: printing reserves and injecting them into the system. However, the current crisis is unique: it is not driven by quarter-end factors, but rather by structural shortages. The weekly SOFR spread reached a new high since March 2019, signaling a deeper problem.

III. Macro Causes of Liquidity Shortage—A Double Squeeze of Fiscal and Monetary Policies

The liquidity shortage was not sudden, but rather the cumulative result of multiple factors. Key drivers include the massive fiscal deficit, the restructuring of the TGA, the depletion of reverse repos, and quantitative tightening.

First, the US fiscal deficit is staggering. Currently, the deficit accounts for 7% of GDP, unprecedented in non-recessionary or non-war periods.

From a 2% surplus in 2001 to a 7% deficit today, the deficit has expanded procyclically. This means the government needs to issue bonds equivalent to 7% of GDP each year, which the bond market buys in dollars. This drains liquidity from the system, especially in a high-interest rate environment. Secondly, the Treasury General Account (TGA) has been rebuilt from $300 billion to $810 billion, removing $500 billion from the financial system. This is directly reflected in the decline in bank reserves to around $3 trillion. Third, the reverse repo "buffer" has been depleted. In the summer of 2023, when then-Treasury Secretary Janet Yellen reestablished the TGA, reverse repos had a $1.8 trillion buffer; now, it's practically zero, unable to absorb liquidity shocks. Fourth, the Federal Reserve's quantitative tightening (QT) continues to shrink its balance sheet and reduce bank reserves. Conversely, quantitative easing (QE) injects reserves by purchasing Treasury bonds and mortgage-backed securities. Following the 2019 repo crisis, the Fed immediately restarted QE; now, if the SOFR remains elevated, similar intervention may be unavoidable. These intertwined factors have led to a dollar shortage. While unemployment is low, the deficit has not improved accordingly, indicating policy misalignment. A K-shaped economy is exacerbating the divide: the upper classes benefit, while the lower classes struggle, impacting consumer lending and CRE. Regional bank problems and repo market pressures are no coincidence. Liquidity tightening increases financing costs and amplifies bad debt risks. While the specific mechanisms require further study, the two are intuitively related. IV. Potential Risks and Market Outlook: Beware of Credit Event Contagion Current developments foreshadow multiple risks. First, a credit event could erupt. If bad debt write-offs continue, regional banks' solvency could be compromised, triggering deposit outflows and a stock price crash. The 2023 crisis saw a record three bank failures; similar signs are emerging now. Second, the spread is spreading to private lending and the broader credit market. Widening credit spreads (rising LQD/HYG) reflect deteriorating liquidity and rising default risk. Credit spreads are not only a liquidity indicator but also a measure of credit risk differentials. Investors can monitor the spread between US Treasuries and investment-grade/high-yield bonds. Third, equity market volatility is increasing. The sharp drop in S&P 500 futures in early trading suggests wavering confidence. If the liquidity shortage persists, the stock market could experience a further correction. Policy responses are key. The Federal Reserve may end quantitative tightening and restart quantitative easing to inject reserves. The US Treasury could adjust the management of the TGA to release liquidity. However, in an environment of high inflation, easing policies must be approached with caution. The liquidity shortage and intensified pressure in the repo market, coupled with the plunge in bank stocks, constitute the core challenges facing the current financial markets. This isn't just a technical issue; it's the product of an imbalance in macroeconomic policies. Based on historical lessons, the Federal Reserve needs to respond quickly to prevent the crisis from escalating. Investors should strengthen risk management and monitor key indicators.