Treasury Market Resilience and the Early End to Balance Sheet Runoff

The Federal Reserve announced it will halt Treasury balance sheet runoff effective December 1, 2025, ending the quantitative tightening program three years after it began. For banks managing liquidity, this shift marks a critical inflection point in reserve availability and funding costs. The decision came after mild stress and increasing pressure in money markets that exceeded the resilience improvements outlined below. While the depleted market capacity from low ON RRP balances, elevated short-term Treasury issuance, and rising borrowing costs forced the Fed's hand earlier than forecasted.

The Fed will continue MBS runoff at $35 billion monthly but will stop the $5 billion monthly Treasury runoff. The Fed is being proactive, as reserves technically still have room above the critical threshold where real issues would occur. Reserves would need to fall below $2.7-2.5 trillion before significant stress emerges.

The U.S. Treasury market has weathered multiple stress episodes over the past five years, prompting a coordinated reform effort from federal agencies and market participants to strengthen its infrastructure. Many believed that these improvements, combined with current reserve levels, would allow the Federal Reserve to continue reducing its balance sheet well into 2026 without triggering the kind of disruption seen in September 2019. However, the Fed's October 29 announcement to halt Treasury runoff on December 1, 2025 demonstrated that market pressure emerged sooner and the Fed chose to act proactively.

The September 2019 episode exposed critical vulnerabilities. Repo rates spiked above 10%, Treasury spreads widened across the curve, and off-the-run securities became difficult to monetize. The problem wasn't a lack of liquidity. It was that primary dealers couldn't absorb the volume of bonds in stressed conditions. Banks had enough balance sheet capacity, but Treasury clearing mechanisms faced constraints in using them as HQLA during stress.

The Interagency Working Group on Treasury Market Surveillance has made substantial progress since then. The Treasury's buyback program, launched in May 2024, directly addresses liquidity for off-the-run bonds. Expanded clearing requirements will reduce counterparty risk and improve transparency. Enhanced data collection through updates to Form PF and the FR 2004C reporting gives regulators better visibility into repo markets and hedge fund positioning. The Standing Repo Facility provides support when overnight repo rates surge, and it's already been used at quarter-ends and tax dates in 2025.

Vice Chair Barr has emphasized making reserves and Treasuries more substitutable in bank liquidity management. When that happens, banks will have more flexibility to meet stress scenarios without fire sales. The Treasury market will function more like cash, which is exactly what this means in practice.

Through October 2025, quantitative tightening proceeded at a measured pace of roughly $40 billion monthly, Treasury cap $5B, MBS cap $35B per the March 2025 decision. Reserves currently stand at $2.89 trillion as of November 19, 2025. The overnight reverse repo facility, which peaked above $2 trillion, has now declined to near zero. This means all growing reserve scarcity comes from reserves on ON RRP declines.

Where's the floor? Three approaches help triangulate the answer. Governor Waller suggested that reserves below 8% of GDP, about $2.7 trillion in today's economy, could be problematic. Compared to 2019, when reserves plus ON RRP loaded roughly 40% of the Fed's balance sheet, financial plumbing today would be around $2.7 trillion. Scaling by banking system size, with assets now at $25 trillion versus $17 trillion in 2019, the comparable floor would be closer to $2 trillion, though a wider buffer makes sense given larger Treasury issuance and greater TGA volatility.

These estimates converge around $2.5 trillion as a reasonable threshold. With reserves at $2.98 trillion as of early October, this left roughly $500 billion of room in theory. However, the rule of the early October 29 announcement to end Treasury runoff by December 1 indicates that market pressure emerged before reserves reached the estimated floor. The rapid depletion of ON RRP to near-zero levels, combined with elevated short-term Treasury issuance and rising funding costs, created strains that the improved infrastructure could not fully absorb.

Two factors complicate this timeline. The Treasury General Account balance creates mechanical swings in reserves. When the Treasury draws down the TGA to make government payments, reserves increase. When the Treasury rebuilds the TGA after depleting it, reserves contract. This happened in 2023 when the TGA jumped $600 billion in just three months, reserves declined sharply. Tax season amplifies these dynamics, with large inflows when payments are due and outflows during refund periods.

The Fed's decision to halt Treasury runoff in December 2025 means these TGA dynamics will now affect reserve levels without the additional drainage from balance sheet reduction. A typical tax season with net hundreds of billions between the TGA and bank reserves. With Treasury runoff halted, the Fed will rely more heavily on its Reserve Demand Elasticity tool, repo spreads, SOFR behavior relative to IORB, and Standing Repo Facility usage to monitor reserve adequacy as TGA fluctuations create volatility.

What This Means for Bank Liquidity Management

For bank treasury and ALM teams, the Fed's decision creates a more stable but still dynamic liquidity environment. With Treasury runoff halted, the baseline level of system reserves should stabilize around current levels, reducing the risk of sudden scarcity-driven funding cost spikes. However, banks should not assume abundant reserves. The $2.89 trillion level provides only a modest cushion above the estimated $2.5-2.7 trillion threshold, and TGA swings will continue to create periodic tightness.

Practical implications include maintaining flexible access to the Standing Repo Facility, particularly around quarter-ends and tax dates when TGA dynamics create temporary reserve drains. Banks should also monitor SOFR-IORB spreads as a real-time indicator of funding pressure, widening spreads signal tightening conditions even when absolute reserve levels appear adequate. The improved Treasury clearing infrastructure means HQLA portfolios should function more reliably in stress scenarios, but banks should still stress-test liquidity positions against potential reserve volatility.

Looking ahead, the Fed's shift to organic balance sheet growth, roughly $20 billion monthly to match GDP expansion, suggests a new equilibrium where reserve levels grow modestly with the economy rather than contracting. This provides a more predictable backdrop for liquidity planning, though banks must remain attentive to regulatory expectations around liquidity buffers and continue building resilience against potential market disruptions.

Vijay Jadhav is a Director at a Big Four consulting firm, specializing in treasury and liquidity risk management, with over 15 years of experience across leading financial institutions, including Citibank, Barclays Capital, and EY. He is the author of a blog and a weekly financial newsletter, “Primal Thesis,” where he provides macroeconomic analysis, bank treasury insights, and market analysis that have consistently proven accurate in predicting major financial events, including the impact of tariffs and market corrections. Vijay's expertise spans bank liquidity management, regulatory reporting, and financial markets, with a particular focus on helping institutions navigate complex regulatory frameworks like LCR, NSFR, and ILST.