Federal Reserve "Emergency Brake": Liquidity Dilemma After Bank Collapses

Reserve Funds Fall Below Psychological Threshold, Market Sends Alarm

2.93 trillion USD — this number became the most closely watched indicator on Wall Street by the end of 2025. As of the week ending December 18, the Federal Reserve banking system’s reserve balance hit a new low since June, down $40.1 billion from the previous week. From the peak of $3.2 trillion at the end of last year, the Fed has drained $270 billion in liquidity from the banking system over six months.

What’s more concerning is that after this figure first fell below the psychological barrier of $3 trillion at the end of September, it has never recovered. Once considered merely a technical indicator, reserve balances have now evolved into a barometer of the global liquidity crisis.

Three Years of “Bloodletting”: The Full Process of the Fed’s Balance Sheet Reduction

To understand why the current situation is so tense, we need to look back at the aggressive policy shift in 2022.

That year, the U.S. economy was hit by inflation pressures unseen in decades. The Fed launched a bold move—quantitative tightening (QT). Simply put, it allowed maturing Treasury bonds and mortgage-backed securities (MBS) to naturally expire without reinvestment. At its peak, the monthly runoff included:

• $6 billion in Treasury maturities
• $3.5 billion in MBS maturities
• totaling up to $9.5 billion in liquidity drained from the system each month

This pace of draining continued for nearly three years. By June 2024, the Fed began to slow down, reducing the Treasury runoff from $6 billion to $2.5 billion. In April this year, it further decreased to $500 million, while MBS runoff remained at $3.5 billion. By October 2025, the Fed’s balance sheet had shrunk from a high of $8.96 trillion in April 2022 to $6.54 trillion—a total reduction of $2.42 trillion.

Reserve funds in the banking system were gradually eroded during this “orderly retreat.”

Turning Point: The Fed Finally Admits Defeat

By October, the market’s “cry for help” signals became impossible to ignore.

On the 15th of that month, the Fed’s SRF tool (permanent repurchase agreement facility) was used passively for $6.75 billion—an unusual move in normal times. The next day, it surged to $8.35 billion, the largest single-day amount outside of quarter-end since the pandemic.

What does this indicate? It shows banks are losing confidence in market financing and are forced to turn back to the Fed’s “window” for help. The market’s self-correcting ability is collapsing.

Fed Chair Powell recognized the danger. On October 30, the Fed announced a major decision: to stop balance sheet reduction starting December 1. This was a sudden halt to the three-year QT policy.

In a 42-minute press conference, Powell explained the rationale behind this decision—essentially: continuing to drain liquidity would cause the U.S. financial system’s blood pressure to spike dangerously. His words were: “Continuing balance sheet runoff would cause reserve shortages, disrupt the transmission of monetary policy to the real economy, and threaten financial stability.”

This policy shift involved four major changes:

1. Stop the passive balance sheet runoff—no more allowing bonds to mature without reinvestment
2. Shift Treasury reinvestment from long-term to short-term—to optimize liquidity structure
3. Dynamic adjustment of the balance sheet size in the future—based on reserve needs, GDP growth, and financial stability goals
4. Officially emphasize this is not QE—but market participants are well aware

Reserve Management Purchases (RMP): A Name Change for “Alternative Liquidity Injection”

After the halt in December, the Fed plans to introduce a new program in January 2026 called RMP (Repo Management Purchases).

The Fed claims this is a “technical operation” to ensure sufficient liquidity in the system. However, market understanding is: this is essentially QE under a different guise.

The underlying reason is quite revealing—banks are willing to finance themselves at higher costs in the market and are reluctant to use their reserves held at the Fed. What does this imply? It indicates a structural blockage in the current reserve system.

Federal Reserve Board member Stephen M. Meren proposed a concept called “regulatory primacy”—new rules requiring banks to hold far more high-liquidity assets than needed for actual operations. In regulatory calculations, cash is often valued more highly than Treasuries, leading banks to hoard cash and further compress the effective reserve system.

Shockwaves: Chain Reactions Across Asset Classes

The Fed’s “admission of defeat” has already begun to ripple through markets.

Bond markets responded immediately. The yield on the 10-year U.S. Treasury dropped from 4.28% before the October 30 meeting to 4.08%. The 30-year yield fell from 4.55% to 4.38%. The narrowing of the yield curve reflects typical “liquidity easing” expectations.

The housing market benefits directly. Fannie Mae economists forecast that the 30-year fixed mortgage rate could fall to 6.3% in 2025, 70 basis points below the 2024 average. This is a significant boon for the long-suppressed housing market.

Corporate financing environment improves markedly. In Q3 2025, total U.S. investment-grade bond issuance reached $450 billion, the highest since Q1 2023. High-yield bond issuance was $11 billion, with credit spreads compressing from 450 basis points at the end of 2024 to 300 basis points in October. Corporate borrowing costs are falling sharply.

Behind this is a critical but often overlooked logical chain: Fed money printing increases liquidity → crypto assets and Bitcoin rise; Fed balance sheet reduction drains liquidity → Bitcoin falls.

Now that balance sheet reduction has paused, liquidity gates are opening, and the “rainy season” for risk assets may truly be arriving.

New Market Order: From “Bloodletting” to “Precise Drip”

From December this year to January next year, the role of the Fed’s balance sheet is undergoing a qualitative shift.

It is no longer an indiscriminate “ATM,” but a system that provides precise “blood transfusions” based on real-time banking system needs. Reserve shortages are met with targeted injections, like IV drips in hospitals.

What does this mean for the crypto market? It signals the end of the cycle of stress caused by the previous aggressive balance sheet reduction. Instead, a new cycle of liquidity expansion is brewing.

The bottom line: when the Fed shifts from “passive bloodletting” to “active drip,” and the banking system’s reserves no longer plummet on a “quarterly” scale, and market financing costs generally soften—the entire risk asset ecosystem will experience valuation expansion.

Powell’s phrase “we’ll see” may sound casual, but the market has already understood: the transition from QT to RMP is not just a technical adjustment; it’s a fundamental reboot of the Fed’s policy framework.