US Money Markets: Circumstances auger for terming out
The desk believes that current US money market conditions favor terming out as the Federal Reserve appears poised to hold rates steady through 2026, contrary to market expectations of rate hikes. Per the full note, the Fed’s bill-buying program has stabilized bank reserves around $3 trillion, and the effective federal funds rate has slightly dipped. This environment suggests that inflation is likely to undershoot the target in the coming years, allowing for a prolonged period of steady rates rather than hikes. Despite a market inclination towards anticipating hikes, the desk emphasizes that consumer behavior and economic indicators support a wait-and-see approach from the Fed, which should stabilize and potentially strengthen USD pairs in the upcoming months.
What the desk is arguing
The desk posits that terming out in the current money market environment presents a favorable strategy, as indicated by the Fed's plans to maintain policy rates through 2026. The supporting evidence stems from the recent stabilization of bank reserves at approximately $3 trillion and a slight decrease in the effective federal funds rate, highlighting reduced market pressures. This perspective aligns with an overall assessment that inflation is trending downward, which seems supportive of the Fed's stance on rates.
Moreover, factors like weak wage growth and falling real household disposable income signal less immediate inflationary pressure, potentially dampening core inflation moving forward. Consequently, the desk anticipates an environment conducive to maintaining rates at neutral levels, providing further rationale for a terming out strategy amid prevailing market uncertainty.
Where it sits in our coverage
The current consensus targets for EUR/USD see it at 1.1700 (range: 1.1200–1.2000), while firms like citi and mufg project targets of 1.1300 and 1.1800, respectively, by December 2026. As the desk's call to term out would suggest elevated confidence in the USD's strength against these currencies, it aligns closely with the upper bounds of the consensus spread.
How other firms see it
Several firms are aligned with the desk's view, including hsbc and goldman, both suggesting targets around 1.1700 for EUR/USD by March 2026. Conversely, firms like citi project lower targets, which might reveal a divergence in views on market direction. Notably, the central bank actions, particularly the Fed's Dovish stance, are creating various perspectives across different market participants regarding potential rates and currency movements.
What the calendar says
With no significant calendar events upcoming in the next month, traders should keep a close eye on how the broader economic narrative evolves, especially with energy prices influencing inflation expectations and subsequently the Fed's policy trajectory.
01The desk advocates for terming out in US money markets due to stable bank reserves and a dip in effective funds rate.
02Current conditions suggest the Fed will maintain rates through 2026, countering market expectations of imminent hikes.
03Weak wage growth and lower disposable income are expected to dampen inflation, supporting the desk's perspective.
04Consensus targets for EUR/USD indicate a broad recognition of USD strength, with the desk's views aligning near the upper range.
Market implications
Watch for EUR/USD as it approaches the consensus target of 1.1700 amidst the prevailing Fed narrative. Given the lack of scheduled events, focus on shifts in market sentiment influenced by broader economic data.
Risks to this view
A significant rebound in wage growth or unexpected increases in inflation could prompt the Fed to reconsider its current stance, potentially reversing the desk's outlook on terming out strategies.
Articles US Money Markets: Circumstances auger for terming out 14:19 Rates Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Repo has calmed as a consequence of the Fed's bill-buying programme, which in turn has helped stabilise bank reserves in the $3tr area. Even the effective funds rate has finally managed to dip a tad. We like terming out here, as the market is discounting rate hikes, and we don't think the Fed will deliver hikes, on the view that inflation comes down Padhraic Garvey, CFA The US Federal Reserve, currently under construction The Fed to hold for the rest of 2026 It is a very close call whether the Fed will hike rates this year, but on balance, we think it will instead choose to look through a near-term energy spike and hold rates steady for an extended period.
The low-hire, low-fire economy means weak wage growth, with real household disposable income having fallen for three consecutive months. Consequently, elevated energy costs risk demand destruction that should help to dampen core inflation in time. Consumer and market inflation expectations remain in tolerable ranges, and slowing housing rents, weak wage growth, a waning influence from tariffs and energy price falls mean that inflation should undershoot the target in the second half of 2027.
This environment should give the Fed room to resume moving policy rates back to neutral in 2027. Fed funds rates versus the SOFR rate SOFR minus effective Fed funds rate) Source: Macrobond, ING estimates "> Source: Macrobond, ING estimates The effective funds rate versus SOFR The effective funds rate used to trade just 8bp above the funds rate floor. The ratchet higher to 14bp in September/October 2025 prompted the policy of renewed T-bill buying.
The backstory saw bank reserves dip below US$3tr, and repo had shown a marked tendency to tighten, with bank reserves at sub-$3tr. That repo tightness, in a relative value sense, was the genesis of the relative rise in the effective funds rate. Since then, the effective funds rate has dipped back down to 3.62% and is now back up at the 3.63% level.
And by the way, that’s just 2bp below the rate paid on reserves (3.65%). It’s actually tough to get to 3.65%, as then eligible counterparties have a choice between two windows (reserves vs funds rate). It should not go above, though.
The other competition for avenues for market liquidity is repo, as encapsulated by the SOFR rate (basically an amalgamation of repo rates). Different players in the market with varying rights in the reserves bucket or the reverse repo bucket will see SOFR as an alternative rate that gets deployed from a relative value perspective. This is important for framing where the effective funds rate actually sits.
SOFR should, in theory, trade below the effective funds rate, as it is a collateralised rate. And in the funds market, we also need to account for the Federal Home Loan Banks (FHLBs). They provide funds to typically smaller banks.
The FHLBs cannot post in the Fed’s reserves bucket, but they can post at the Fed funds rate. In fact, they tend to be dominant players in the current funds rate market, especially as the commercial banks will prefer to post at the higher excess reserves rate. Bottom line, they are effective funds rate influencers.
The latest impulses show repo trading far easier than it was. SOFR, in consequence, has shown a tendency to trade through the effective funds rate. That is a symbol of relative stability in money markets, apart from month-end, but even then there has been reduced volatility.
We expect more of the same ahead based on the current policy of maintaining reserves at or above $3tr, alongside ongoing buying of T-bills, as an offset to the roll-off of mortgage-backed securities (while the Fed's holdings of Treasuries remain unchanged). The Fed's bond and bills holdings USD, billions Source: Macrobond, ING estimates "> Source: Macrobond, ING estimates Since the Fed recommenced T-bill buying in mid-December 2025, it has bought a cumulative $290bn. Overall, the Fed's holdings of all securities (including bills) are up $210bn, to almost $6.35tr.
That has coincided with a rise in bank reserves holdings to over $3tr. New Fed Chair Kevin Warsh came into the job in the wake of various suggestions that the Fed should reduce the size of its balance sheet. We covered the issue here , and noted that at the end of 2005, the Fed’s balance sheet was about 5.5% of GDP.
Roll on 20 years, in and out of the global financial crisis and pandemic, and it’s now 21% of GDP (quadrupled). The driver was bond buying. Total bonds held by the Fed were around 5.5% of GDP 20 years ago.
That now equates to 20% of GDP (almost quadruple). Bank reserves were purely regulatory in nature and a puny 0.1% of GDP 20 years ago. Today’s bank reserves are closer to 10% of GDP (100-fold).
Kevin Warsh wants to 'fix it', it seems. The technicalities could require the sale of all mortgage-backed bonds ($2tr) and at least half of the Treasury bonds (c.$2.5tr). So that’s some $4.5tr in total, and would bring Fed bond holdings back down to around 5.5% of GDP (pre-GFC proportions).
That in itself is big, and raises questions about a doable pace. On the other side of the balance sheet there is the complication of transitioning from the current excess bank reserves environment back potentially towards a scarce regulatory bank reserves environment. On the former, a Congress-legislated special purpose vehicle tasked with taking the bonds off the Fed’s balance sheet has been mooted (so they would not be “sold”).
On the latter, an easing in bank liquidity ratios would be required. For now, it’s all quite speculative. But what we do know is Warsh can’t simply sell bonds and stop there.
He would need to address both sides of the balance sheet, and make regulatory changes to bank liquidity requirements. Bank reserves at the Federal Reserve Alongside the Fed's repo (adding liquidity) and reverse repo facilities (taking out liquidity) Source: Macrobond, ING estimates "> Source: Macrobond, ING estimates Then there is the complication of a transition from the current excess reserves environment, potentially back towards a "scarce reserves" environment, as indicated by Warsh (but without specifics). Selling the bonds is relatively straightforward; far less straightforward is how to get back to the prior regime for reserves management and how the funds rate is set, along the way, and in the future.
One aspect that can help here is the revision to the leverage ratio requirements as of 1 April 2026. The fact that the larger banks will, as a result, have more capacity to buy Treasuries and/or engage in repo is potentially a huge benefit. The weak link in the current structure has been the capacity for tightness in repo to bully the effective funds rate higher, primarily on a relative-value play.
Larger banks in the game could and should tame the tendency for repo to over-tighten at times. There is a link here with reserves, too, as the Federal Reserve has reverse-engineered a logic that repo tightness was associated with the fall in excess reserves to a level that exacerbated repo tightness. While a clear link between the two is not necessarily obvious, one does exist.
We saw the same when the Fed went through its first quantitative tightening exercise in 2019, which culminated in a brief but severe repo tantrum. It was calmed through the Fed's decision to buy bills from December 2026, and that policy continues as we head into the second half of 2026. Money market funds remain on the rise Also on the rise as per cent of nominal GDP Source: Macrobond, ING estimates "> Source: Macrobond, ING estimates Inflows to money market funds remain firm, with both institutional and retail participating.
Prime funds continue to see their fair share of the increase. As a percentage of GDP, total money market funds are now approaching 25%, not far off the previous high of 27% in 2009. So far, the rate level has not been a material issue, mostly as a return of 3-4% still represents a decent return on what is effectively a 'zero risk' product.
The latest data shows money market funds holding steady, while large bank deposits have seen some decent inflows. Money market fund holdings Government Funds on top, and Prime Funds on the bottom In terms of specific exposures, Government Funds have seen a renewed rise in holdings of Treasury Debt (effectively bills). Extra bills are being issued to take pressure off coupon issuance.
This should help maintain a concession in bills. Repo has been downsized relative to bills' holdings as a result, although repo has been on the rise recently. In Prime Funds, repo (reflecting equity repo) exposures remain elevated, albeit off prior highs.
Exposure to commercial paper (CP) has been gradually rising, while certificates of deposit (CD) and ordinary deposits have been steadier to a tad lower. Bank deposits have seen resumed rises, mostly into the larger banks (less so into the small banks). Commercial paper alternatives As spreads above the Fed's reverse repo rate (bp) Source: Macrobond, ING estimates "> Source: Macrobond, ING estimates In terms of attainable rates, the entire spectrum of overnight commercial paper rates remains comfortably above the Federal Reserve's reverse repo rate.
This has reflected past relative tightness in repo, which has acted as an upward drag on other rates from a relative-value perspective, and on a concessionary T-bills environment. That has tamed in recent months. The market is discounting rate hikes, which has built concessions.
If we are correct that the Fed does not hike, and ultimately the next move is down, then terming out in spread products at current levels could be seen as a decent play. Terming out From overnight (o/n) to three months (3mths), bp Source: Macrobond, ING estimates "> Source: Macrobond, ING estimates Rates Money Markets Update Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument.
Read more Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download Author Padhraic Garvey, CFA Regional Head of Research, Americas Padhraic Garvey is the Regional Head of Research, Americas. He's based in New York. His brief spans both developed and emerging markets and he specialises in global rates and macro relative… In this article The Fed to hold for the rest of 2026 The effective funds rate versus SOFR
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