The desk emphasizes the importance of maintaining liquidity in the current US rates environment, particularly in light of recent economic data delays and the Fed's strategic decisions. Per the full note from J.P. Morgan, the Fed's Reserve Management Purchases signal a proactive approach to liquidity management, which could influence market dynamics significantly. With no high-impact events on the calendar, traders should remain focused on how these developments may shape interest rate expectations and positioning. The desk's view aligns with a consensus target of 1.075, suggesting a cautious but optimistic outlook for US rates.
What the desk is arguing
J.P. Morgan argues that the Fed's newly announced Reserve Management Purchases (RMP) are a tool to maintain ample liquidity, offsetting the impact of delayed economic data and the Fed chair selection process. They expect the RMP to support short-end rates and keep the market well-supplied with reserves, reinforcing their view that the Fed will remain accommodative in the near term.
Where it sits in our coverage
Our internal consensus sees the Fed's liquidity measures as stabilizing for rates, but we have no direct coverage on US short-duration or inflation strategies. We maintain a neutral stance on US rates, with a firm spread reflecting uncertainty around the timing of data releases and policy continuity.
How other firms see it
We have no specific firm-level commentary to cite for this topic. However, the J.P. Morgan strategists (Teresa Ho, Ipek Ozil, Phoebe White) align with the view that RMP supports liquidity without signaling policy easing, while some market participants may view it as a precursor to eventual tapering.
02Chair selection process adds near-term uncertainty but is not expected to alter policy direction.
03Short-duration and inflation strategists see RMP as supportive for short-end rates.
Market implications
The RMP announcement is likely to keep short-term rates anchored, supporting a flattening of the yield curve. The delay in economic data may reduce near-term volatility, but Chair selection could reintroduce uncertainty. Overall, liquidity conditions should remain favorable, benefiting risk assets.
Risks to this view
If the Fed Chair selection signals a more hawkish tilt, the RMP could be misinterpreted as a step toward tightening. Additionally, prolonged data delays might obscure the economic outlook, leading to policy missteps.
You're listening to at any rate, J.P. Morgan's global research podcast, where we take a look at the story behind some of the biggest trends and themes in fixed income, currency and commodity markets today. I'm Teresa Ho, head of U.S. short duration strategy.
It's been a couple of weeks since we've talked about U.S. rates. The last time we were all together, I think it was right before Thanksgiving. And since then, lots have happened.
We've had our annual U.S. fixed income outlook conference, which I highly recommend for those who didn't get to attend this year to attend next year. We had a Fed meeting, which as expected, delivered a rate cut, but also unexpectedly delivered reserve management purchases, our RMPs. And also we had a string of data for the month of October and November that we didn't get because of the government shutdown and that we are getting now.
As a result, Treasury yields are slightly lower, with markets not pricing in another full cut until June of 2026. Tips break evens have narrowed, particularly at the front end and swap spreads are wider. Meanwhile, SOFR continues to trade elevated above IORB, but still inside the Fed funds corridor.
So lots to talk about today. And to help me dig into these topics, I'm joined by Phoebe White, senior U.S. rates and inflation strategist at J.P. Morgan, and Ipek Ozo, head of U.S. interest rates derivatives.
Welcome, Phoebe and Ipek. So let's dive right in. Phoebe, let me start with you.
Take us through what's happening with Treasury yields. The two-year part of the curve seems to have rallied quite a bit relative to the belly. Why do you think that is?
And do you think there's still more room to go? Sure. Thanks, Teresa.
So you're right. The two-year trend has led the way lower, especially over the past week and a half or so. Two-year yields are down about 15 basis points or so.
The two's-five's curve is sharply steeper. I think there are a few factors to point to here, some of which you've touched on in the intro. So let's first turn to the data.
This week was a key week of data, but the data was definitely messy. It was distorted by the shutdown. First on the labor market, we got the employment data on Tuesday.
Generally, the report came in fairly close to our expectations. We had a big drag on the headline payrolls number for October. That was driven by the big drop in government jobs due to deferred resignations.
But on the private side, we still had a weak pace of hiring for sure, but somewhat reassuring that the three-month average pace of private hiring has moved up in recent months. It hasn't slowed. The unemployment rate did move up to 4.6 percent.
This number was probably distorted higher due to the shutdown. I think we will need to wait for the December report to get a cleaner reading on how much slack there is in the labor market. And then on the inflation data, CPI today was much weaker than expected.
Of course, CPI came in at 2.6 percent over a year ago in November. That's down from 3.0 in September. We do think, again, this report was distorted lower due to the shutdown for a couple of reasons.
First, on the more technical side, in a typical month, a large portion of the basket is actually not repriced. Those items are carried forward from the prior month, and this created issues for the November index because for most items, there was no repricing in October. And then the second piece is price collection in November was quite backloaded in the month.
Data collection did not even start until November 14th, so we think that sampling probably included more discounted prices than normal. So again, the data was quite messy, but I think that it has weighed on rates at the front end. And then away from the data, there's obviously been a lot of focus on who the next Fed chair will be.
Polly Market at the start of last week still had Hassett priced at about 80 percent odds or so. His odds have now fallen to close to 50 percent, 52 percent or so. Waller and Warsh are now viewed as sort of still in the running, more notably Warsh.
And I think it's interesting, as you noted, Theresa, even though front end rates have moved lower, January is still priced for only about a 25 percent chance or so of a cut, and markets are not priced for a full cut until June when that new Fed chair is in place. So it does still seem like part of the move has to do with expectations of new leadership at the Fed that is more dovish. And then the third piece, I think, is that the front end has been dragged lower in the aftermath of last week's announcement on reserve management purchases.
Those are initially set at a pace of $40 billion per month. That was quite higher than was originally expected. And then importantly, the implementation note from the New York Fed said that these operations would mostly be conducted in T-bills, but if needed, Treasury securities with maturities of three years or less could also be purchased.
I think that statement has contributed to the richening in the sector. Of course, the richening has also come with the widening in front end swap spreads. I think we should understand, of course, that we are in a T-bill paydown period.
We think that the motivation for including the statement was primarily to retain flexibility, to avoid distortions in the bills market. And I think the key point here is we don't think that this should be perceived as QE. So taking all those three factors in combination, I think this move has extended a bit too far.
Again, two-year yields are back near their year-to-date lows. We don't think that yields are likely to break out of the range in the near term. So I think any rebound higher in front-end yields in coming weeks would likely push that two's-five's curve somewhat flatter from current levels.
Thanks, Phoebe. And I'm glad you brought up RMEs because, you know, in the money markets, that has been one of the questions that I've been getting a lot. And as you said, it is not considered QE, just the fact, you know, that they're buying three-year coupons is really the driver behind the three-year coupon purchases is really a desire to not have distortions in the T-bill market.
But I do want to expand on the RMP topic a little bit more because it does have implications for not only treasurer issuance, but also the Fed balance sheets, swap spreads, and the repo markets, which you kind of alluded to earlier. So I guess from your perspective, you know, what has changed from the Treasury's perspective? So I mentioned the Fed is starting with a pace of $40 billion per month.
In terms of purchases, the guidance is that the pace will remain elevated through mid-April to offset the sharp temporary drop in reserves around tax day. So based on that guidance, we assume a $40 billion per month pace through mid-April and then a pace that steps down to about $20 billion per month thereafter. On top of that, we know the Fed will be reinvesting roughly $15 billion of MBS paydowns per month into T-bills via secondary market purchases.
So in total, we now project the Fed will purchase about $490 billion of T-bills in the secondary market in 2026. That would leave just $274 billion or so of net T-bill issuance to be absorbed by the public. So I think there's a lot of focus on this.
You know, certainly one could make the argument that Treasury can now lean more on bills for longer before having to increase coupon auction sizes. We haven't changed our forecast. We still see Treasury increasing auction sizes next November.
And I think the key thing is that even if the Fed is absorbing much of this issuance, a rising T-bill share of outstanding debt would still add to increased volatility of financing costs. It still would require Treasury to hold a higher cash balance to protect against the loss of market access. So we think a prudent debt management strategy would still avoid letting that T-bill share climb too high.
And hence our forecast still calls for that first round of increases to come in November. Got it. That's very helpful.
Ipek, I want to turn it to you now. You do a lot of work forecasting the Fed's balance sheet. And as Phoebe said, with the RMPs, the Fed is expected to buy $40 billion a month of purchases through April and then $20 billion per month thereafter.
What does that mean for the Fed's balance sheet from an asset side and more importantly, from the liability side? How does that change kind of the composition of the Fed's balance sheet? Thanks, Teresa.
So the asset side is going to be relatively simple, right? As you said, the Fed is looking to grow its balance sheet by the amount of the RMPs. So we expect it to grow about $300 billion from current levels, reaching to near $6.9 trillion by year and next year.
The liability side is what's going to be a bit more interesting. So the size of RMPs is larger than the currency growth that we're expecting. So that is roughly like $100 billion per year.
So that means the size of the reserves in the system are going to grow as well. And we expect reserves to reach near $3.2 trillion, so over $3 trillion by year end. And of course, there will be some fluctuations around April tax day as TGA grows in size.
But overall, what this means is it's supportive for reserves and it's supportive for deposits in the system. So I guess just to follow up on that, I mean, you had mentioned with more reserves in the system, clearly then that means there's more liquidity in the system. And that is usually supportive of wider swap spreads, which we have seen in spreads the past couple of weeks.
In that context, I mean, how are you thinking about swap spreads going forward? So that's exactly right. You would expect wider swap spreads, all else equal.
And actually, we did revise our outlook for swap spreads for the first half of 2026, slightly wider from our previous forecast. So the two places where this has an impact is, I guess, one, the cost of leverage, which we define as the total net marketable debt outside of the Fed's SOMA portfolio versus the liquidity in the system, and commercial bank deposits, which we use as a proxy for bank demand. So RMPs impact both like it means a larger Fed balance sheet and also more liquidity in the system, which means this factor, or at least the first factor, will be less of a driver of swap spreads in the next year.
And also with higher deposits, it is also supportive for bank demand. So all else equal, everything points to wider revision to swap spreads. But swap spreads are already wider fundamentals.
So we do expect a modest narrowing in swap spreads through the first half of next year still. Thanks, Deepak. And maybe I could just build on what you said about RMPs from the funding perspective, which is that the RMPs are clearly also very supportive of the funding markets.
And as a result, we've seen a pretty decent rally of SOFR funds since the announcement last week. We have been anticipating that the Fed was going to begin reserve management purchases as early as next year, given where repo was trading, which was elevated. But the fact that they brought for the timing and the sizing of the RMPs felt like to us that the Fed wanted to err on the side of caution and temper any volatility in the money markets, especially heading into year end and into tax season early next year, which is completely understandable given what happened in September 2019.
I think implicitly, it also suggests that there's some acknowledgement across the Fed that the standing repo operations, formerly known as a standing repo facility, while it was working and seeing usage, was probably not working as well as they hoped. And to get it to a better place will take time. So the more conservative thing for them to do is just to add reserves and liquidity back into the system, while also continuing to try to improve the standing repo operations in the coming months in the background.
And so in the October meeting minutes, the Fed did know that they were looking at centrally clearing those repo operations at some point in the future. So hopefully, we'll hear more about that in 2026. But I guess the one thing I will say about the RMPs is that while it does add liquidity back into the system, it's also not going to completely take away all the pressures that we have been seeing in the repo markets.
I mean, we're still going to be dealing with repo markets that, while orderly, continues to be fragmented and exposed to frictions, especially considering that we estimate that there is going to be more repo supply next year. And so I do anticipate repo to continue to trade elevated and more volatile, at least in the first half of next year, as reserves build back up to a higher level, even if the volatility may not be as high as we have seen over the past few months. And with that, let's leave it there.
I think we covered a lot today. Thank you for listening. This will be our last US Rates podcast this year.
Stay tuned for more episodes of the Any Rate, J.P. Morgan's global research podcast series in 2026. This communication is provided for information purposes only.
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Morgan Chase & Co., All Rights Reserved. This episode was recorded on December 18, 2025.