The Fed is “passive” – ​​analysis of the December FOMC meeting

In-depth analysis of the FOMC meeting in December 2025: an undervalued major turn——From the early termination of QT to the restart of “non-QE” government bond purchases, it is no longer “anti-inflation” or “soft landing”, but “preventing liquidity crisis”

On December 10, 2025, the Federal Reserve announced an interest rate cut of 25 basis points as scheduled, lowering the target range of the federal funds rate to 3.25%-3.50%. At the same time, it gave the clearest signal to date in the most unexpected place for the market: it was forced to completely change the original monetary policy framework in two consecutive meetings.Although the Federal Reserve has repeatedly emphasized that this is “not QE” and “does not constitute monetary easing,” in essence, this is a complete replica of the “non-QE” operation in September 2019, and it was started earlier than in 2019 and the background was more severe.

This is not a policy U-turn that is grossly underestimated.

1. All three major points are hit, but the core lies in the third point.

Before the meeting, markets and analysts generally focused on three things:

1. Whether to cut interest rates by 25bp (the probability is close to 100%);

2. Do the dot plots and economic forecasts reflect the expanding influence of the “tariff inflationists”?

3. Whether there will be statements related to reserves and repo in the Implementation Note.

Result:

• The first point fell into place without any suspense;

• The second point is basically in line with expectations. The dot plot has only been slightly adjusted. The median federal funds rate at the end of 2025 has been revised down from the previously expected 3.9% to a range of 3.6%-3.8%, and will remain basically unchanged in 2026, indicating that the committee as a whole still maintains the baseline scenario of “economic rebound in 2026”;

• The third point was the biggest surprise: the Federal Reserve directly announced that “the reserve balance has dropped to a sufficient level and will initiate the purchase of short-term securities (mainly Treasury bills) as necessary” and specified in the implementation details that “it will increase its securities holdings through the purchase of Treasury bills and other methods.”

This means that in just one and a half months, the Fed was slapped twice by reality and had to abandon its planned plan:

• The November meeting announced in advance that QT would end in March 2026 at the latest;

• The December meeting directly announced the restart of QE-like asset purchases.

The only driving force for both shifts is the same: continued tension in the banking system’s reserves (bank reserves) and wholesale financing markets (especially the repo market).

2. The Repo market has entered the “year-end mode” ahead of schedule, earlier than any time in history.

The latest data (as of December 9–10, 2025) shows:

• The SOFR overnight interest rate has remained at 3.90%–3.95% for many consecutive days, which is significantly higher than the IOER (Interest Rate on Excess Reserves) of 3.50%;

• On December 31, the New Year’s Eve repo interest rate has soared to 4.35%-4.60%, which is 80-110 basis points higher than the policy interest rate;

• On key settlement dates such as January 2 and January 15, repo quotations even reached extreme levels of over 5.0%;

• The spread between the GC repo and SOFR has widened to the same extent as before the crisis in September 2019.

More importantly, the start time of year-end financial pressure is significantly advanced.Historical experience shows that in normal years, the year-end effect will not be obvious until after December 20 at the earliest; however, a significant premium will already appear on December 4-5, 2025, and will further rise sharply on December 8-9.This shows that market participants are extremely pessimistic about the supply of liquidity at the end of the year and have begun to “jump in” to lock in financing weeks in advance, forming a positive feedback of leading demand + shrinking supply.

3. Why did the Fed have to take immediate action?

1. Reserves have truly hit the “lower edge of adequacy”.According to the latest weekly report from the New York Fed (week of December 4), the reserve balance of the banking system has dropped to US$2.96 trillion, a decrease of nearly US$700 billion from the high in June 2025, and an evaporation of nearly US$1.4 trillion from the peak in 2022.More importantly, non-reserve liabilities (reverse repo balances) have fallen to around $380 billion, close to 2021 lows.The buffer capacity of the reverse repurchase facility is almost exhausted. Once reserves continue to decline, liquidity pressure will be directly transmitted to money market interest rates.

2. Bank balance sheet constraints have never been tighter.Since 2025, the final rules of Basel III (Supplementary Leverage Ratio SLR, GSIB Additional Capital, etc.) have taken full effect, and major U.S. banks generally regard Treasury bonds and reserves as equally high-quality liquid assets (HQLA).Against the backdrop of tighter capital constraints, banks are more inclined to hold treasury bonds than to provide repo liquidity, leading to an intensification of the “lender strike” phenomenon in the repo market.

3. Treasury cash balance management adds to seasonal pressures.At the end of fiscal year 2025, the balance of the Treasury’s TGA account once dropped to around US$550 billion, significantly lower than the level of US$800 billion to US$1 trillion in the same period of previous years, which meant that the Treasury’s cash flow back to the market was significantly reduced, further exacerbating year-end liquidity tensions.

Under the resonance of the above three pressures, if the Federal Reserve continues to be “indifferent”, it is very likely that the SOFR overnight interest rate will exceed 5.5% or even 6% from December 31, 2025 to January 2, 2026, an extreme scenario, which will directly repeat the crisis in September 2019.

4. Dot plots and economic forecasts: On the surface, they are full of “hawkishness”, but in fact they cover up greater differences.

At the dot plot level, the median interest rate at the end of 2025 will be revised down by about 25-30bp from September, will remain basically unchanged in 2026, and will increase slightly in 2027. The long-term neutral interest rate will still remain at 2.9%.On the surface, it looks like a “hawkish interest rate cut.”But a deeper interpretation will reveal:

1. The forecast for GDP growth in 2025-2026 is significantly raised (from 1.8% to 2.2% in 2025 and from 2.0% to 2.3% in 2026), and the unemployment rate is lowered (from 4.2% to 2025).3% → 4.1%), while raising the core PCE by only 10bp (2.5% → 2.6% in 2025), showing that the Fed’s baseline scenario is still betting on “a soft landing and rebound of the economy after tariff uncertainty subsides.”

2. The two dissenters went in completely opposite directions:

• Chicago Fed President Goolsbee (a traditional dove) advocates greater easing)

• Kansas City Fed President Schmid (continues to insist on “tariff inflation risks”) The differences between the two just show that the committee has split into three factions:

• Traditional doves (worried about jobs)

• “Tariff inflation caution” (Schmid, Hammack, et al.)

• Mainstream centrists (betting on the economy rebounding in 2026 and unwilling to loosen things too quickly)

This split has made the dot plot lose its clear guiding significance – it is neither a victory for the doves nor a dominance of the hawks, but a compromise product of “everyone has his own say”.

5. Huge deviation between market pricing and reality

As of December 10th after the meeting:

• The January 2026 contract is still only priced at an interest rate cut of about 15bp, with a cumulative rate cut of about 35bp in March, and only 90–95bp for the whole year;

• The market still expects the Fed to “pause” in 2026 as early as the second quarter of 2026.

But combined with the fact that the Fed has been forced to pivot twice, the market has clearly underestimated the future easing slope.Historical experience shows that once the Fed is forced to restart QE-like asset purchases, it will almost certainly be followed by a larger interest rate cut (the interest rate was cut by 75bp within three months after launching non-QE in September 2019; it was directly reduced to zero in March 2020).

Conclusion: Monetary policy has re-entered “liquidity-driven” mode

The greatest significance of the FOMC meeting in December 2025 is not the 25bp interest rate cut, but the fact that the Fed was forced to make a 180-degree turn twice in a very short period of time – from “long-term QT + gradual interest rate reduction” to “immediately stopping QT + restarting Treasury bond purchases.”This shows:

1. The liquidity of the banking system has truly reached the critical point, and the Federal Reserve can no longer continue to be tough.;

2. The monetary policy transmission mechanism has switched back from the “interest rate channel” to the “quantity/liquidity channel”;

3. The future easing path will be determined more by wholesale financing market conditions rather than CPI or employment breakdown data.

To sum it up in one sentence: The Federal Reserve made it clear today thatThe main line of monetary policy in 2025-2026 is no longer “anti-inflation” or “soft landing”, but “preventing liquidity crises.”All subsequent macro narratives must be reframed around this new thread.