The liquidity shortage in the United States and the increasing pressure in the repurchase market.

Financial Market Storm Resurfaces

On the ordinary Friday of October 17, 2025, the global financial markets were shrouded in layers of gloom. The liquidity shortage issue became increasingly severe, with pressures in the repo market escalating, and the SOFR (Secured Overnight Financing Rate) spread reaching a new high since 2019. Meanwhile, bank stocks, especially regional bank stocks, suffered a sharp decline, raising market concerns about potential credit events. This is not just an isolated bank issue, but a signal of tightening liquidity in the entire financial system.

The current market environment is reminiscent of the repurchase market crisis of 2019 and the regional bank crisis of 2023. At that time, a liquidity shortage led to a spike in short-term financing costs, exposing the vulnerabilities of the banking system. Now, similar signs are re-emerging: the weekly spread between SOFR and reverse repo has reached its peak since July 2019, with SOFR even exceeding the Federal Reserve's discount window rate by 5 basis points. This indicates that the shift from excess to shortage of dollar liquidity has become a reality. The plummet of bank stocks further amplifies this concern, especially with regional banks like Zions Bancorporation and Western Alliance Bancorporation experiencing a collapse in stock prices, with a single-day drop setting a record since the regional bank crisis of 2023.

1. Turbulence in the Banking Sector - Is the Regional Bank Crisis Reappearing?

Recent data indicates that the banking sector is experiencing significant volatility, which is the starting point of the current market turmoil.

Due to a high dependence on commercial and industrial loans, consumer loans, and commercial real estate (CRE) exposure, regional banking institutions are often more susceptible to the impacts of economic downturns. Taking Zions Bancorporation as an example, this bank headquartered in Utah focuses primarily on commercial and industrial loans. Recently, the bank disclosed a $50 million charge-off related to two loans suspected of fraud and has filed a lawsuit to recover $60 million. Broader concerns revolve around consumer loan challenges and CRE exposure. It is well known that the commercial real estate market has been persistently weak since 2020, with a high-interest rate environment leading to increased vacancy rates in office and retail properties and a decline in rental income. Zions' stock price experienced a single-day drop that set a new high since the regional banking crisis of 2023; this case is not an isolated incident but rather reflects the vulnerability of the entire industry.

Western Alliance Bancorporation, headquartered in Phoenix, is facing a similar predicament. The bank is heavily reliant on Non-Deposit Funding Institutions (NDFI) loans and is exposed to the automotive and consumer sectors. The low-income group (lower tier of the K-shaped economy) is experiencing weak consumption, which directly impacts the quality of these loans. The bank recently disclosed fraud allegations against borrowers involving First Brands and Ricoh issues, and filed a lawsuit exceeding $100 million. Although the bank maintains its outlook for 2025, the NDFI loan portfolio is under scrutiny for rising bad debts. The plight of these two banks is not coincidental, but rather a product of increasing economic divergence: high-income groups benefit from rising asset prices, while low-income groups suffer from inflation and unemployment pressures.

The turmoil in regional banks has begun to spread to large banks. Data from October 16 shows that Citigroup fell 3.5%, First Capital Financial fell 5.5%, Goldman Sachs fell 1.3%, and JPMorgan Chase fell 2.3%. Although large banks have higher capital adequacy ratios, they are not immune. Institutions like First Capital focus on loans with low credit scores, similar to regional banks, and are vulnerable to consumer defaults. The KRE (Regional Bank ETF) recorded its largest single-day drop since 2023, second only to the “Liberation Day” in April 2023.

To quantify this risk, the credit spread indicator can be examined. The ratio of LQD (Investment Grade Corporate Bond ETF) to HYG (High Yield Corporate Bond ETF) is an effective proxy for high-frequency monitoring of credit spreads. An increase in this ratio indicates that investment-grade bonds are relatively more favored than high-yield bonds, reflecting a widening of credit risk. The true benchmark is the BofA High Yield Option-Adjusted Index, but its daily update frequency is lower. Currently, the LQD/HYG ratio shows a widening of credit spreads, suggesting that bad debt write-offs may impact bank profitability and solvency.

More concerning is the connection between regional banks and private credit. The private credit market has surpassed one trillion dollars, and many regional banks are involved through loans or investments. If bad debts spread, it could trigger a chain reaction. JPMorgan CEO Jamie Dimon referred to it as the “cockroach theory,” meaning one bad debt often signals more hidden issues. This is not limited to the banks themselves but could also affect the broader equity markets. In light of this, S&P 500 futures initially plummeted in the morning session, although there was some recovery, indicating a shake in market confidence.

Looking back at history, the regional bank crisis in 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, the high interest rate environment persists, and liquidity tightening is intensifying, with similar risks resurfacing. As a result, the stock prices of KRE, Zions, and Western Alliance, as well as credit spreads, have garnered significant attention. If bad debts continue to surface, the stability of the banking system will be put to the test.

2. Buyback Market Pressure Escalates - SOFR Spread Hits Historical High

The repurchase market is the core battleground for liquidity shortages. Repurchase agreements (repos) are short-term financing tools that banks and institutions use to borrow funds by pledging securities (such as U.S. Treasuries or mortgage-backed securities). SOFR is the benchmark for repurchase rates, reflecting the cost of overnight secured financing.

This week, the weekly spread between SOFR and reverse repos reached its highest level since July 2019, only 1 basis point higher than last week, but the trend is clear: liquidity has shifted from abundant to scarce. SOFR has exceeded the Federal Reserve's discount window rate by 5 basis points, which is a rare occurrence that typically only happens at the end of a quarter or year. However, these are not those times, and there are no tax deadlines or window dressing factors at play.

On October 16, the Federal Reserve's Standing Repo Facility (SRF) was utilized for $8.35 billion, signaling that the emergency backstop has been activated. The SRF allows institutions to borrow funds against Treasury securities or MBS (mortgage-backed securities). Notably, in this instance of SRF usage, the share of MBS is higher than that of Treasury securities. This may suggest weakness in the MBS market, similar to the liquidity crisis during the pandemic in 2020.

To make this transition more noticeable, one can 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” for excess dollars, while the SRF serves as an “emergency faucet” providing scarce dollars. A negative difference indicates that the system is shifting from surplus to shortage.

The Federal Reserve is attempting to control the repo market through a rate corridor: the discount window rate (4.25%) serves as the upper limit, while the reverse repo reward rate (4%) serves as the lower limit. Currently, just like at the end of 2020 and 2024, the difference between SOFR and the federal funds rate (Fed Funds) is surging in the daily chart. However, SOFR has surpassed the upper limit, indicating an imbalance in market supply and demand.

The repo market crisis is not a new issue. In September 2019, repo rates soared to 10%, prompting a swift intervention from the Fed, which injected reserves by purchasing government bonds and MBS. Weekly charts couldn't even capture the 2019 crisis due to its brevity and the Fed's rapid response. Today, if pressure persists, the Fed may restart similar operations: printing reserves and injecting them into the system. However, the current crisis has unique aspects: it is not driven by quarter-end but rather by structural shortages. The SOFR weekly spread has reached a new high since March 2019, indicating deeper issues.

3. Macroeconomic Causes of Liquidity Shortages – Dual Pressure from Fiscal and Monetary Policies

The liquidity shortage is not sudden, but a result of cumulative factors. The main drivers include massive fiscal deficits, TGA reconstruction, reverse repo exhaustion, and quantitative tightening.

First, the scale of the U.S. fiscal deficit is staggering. Currently, the deficit accounts for 7% of GDP, which is unprecedented during non-recessionary or non-war periods. From a surplus of 2% in 2001 to a deficit of 7% now, the deficit is expanding procyclically. This means the government needs to issue bonds equivalent to 7% of GDP each year, to be purchased by the bond market at an equal dollar amount. This drains system liquidity, especially in a high-interest-rate environment. Secondly, the Treasury General Account (TGA) has been rebuilt from $300 billion to $810 billion, meaning $500 billion has been removed from the financial system. This is directly reflected in bank reserves dropping to around $3 trillion. Thirdly, reverse repos as a “buffer” are empty. In the summer of 2023, when then-Treasury Secretary Yellen rebuilt the TGA, there was a $1.8 trillion buffer in reverse repos; now, it is nearly zero and unable to absorb liquidity shocks. Fourth, the Federal Reserve's quantitative tightening (QT) continues to reduce its balance sheet, decreasing bank reserves. In contrast, quantitative easing (QE) injects reserves through the purchase of Treasury securities and MBS. After the repurchase crisis in 2019, the Federal Reserve immediately restarted QE; now, if SOFR remains high, similar intervention is unavoidable.

These factors intertwine, leading to a shortage of dollars. Although the unemployment rate is low, the deficit has not improved, indicating a policy imbalance. The K-shaped economy exacerbates division: the upper class benefits while the lower class struggles, affecting consumer loans and CRE.

The issues with regional banks and the pressures in the repurchase market are not coincidental. The tightening of liquidity raises financing costs and amplifies the risk of bad debts. Although the specific mechanisms require further research, the two are intuitively related.

4. Potential Risks and Market Outlook - Beware of Contagion from Credit Events

Current dynamics indicate multiple risks.

First, credit events may erupt. If bad debt write-offs continue, regional banks' solvency will be impaired, leading to deposit outflows and stock price collapses. During the 2023 crisis, three banks collapsed, setting a record; now, similar signs are emerging. Second, there is a contagion to private credit and the broader credit market. Widening credit spreads (LQD/HYG rising) reflect deteriorating liquidity and increasing default risks. Credit spreads are not only a liquidity indicator but also measure the differences in credit risk. Investors can monitor the spreads between U.S. Treasuries and investment-grade/high-yield bonds. Third, volatility in the equity market is intensifying. The early morning plunge in S&P 500 futures indicates shaken confidence. If the liquidity shortage persists, the stock market may further correct.

Policy response is key. The Federal Reserve may end quantitative tightening and restart quantitative easing to inject reserves. The U.S. Treasury can adjust TGA management to release liquidity. However, in a high inflation environment, accommodative policies must be cautious.

The shortage of liquidity and intensified pressure in the repo market, combined with the plummeting of bank stocks, constitute the core challenges of the current financial market. This is not only a technical issue but also a product of macro policy imbalance. Based on historical lessons, the Federal Reserve needs to respond quickly to avoid escalation of the crisis. Investors should strengthen risk management and monitor key indicators.