The Federal Reserve's strong return to the short-term bond market Wall Street urgently raised expectations for the scale of debt purchases

The Federal Reserve announced a monthly purchase of 40 billion US Treasury notes starting this Friday. The scale is higher than the market's previous expectations. The purpose of this move is to ease short-term interest rate pressure by supplementing the banking system's reserves. This move immediately triggered a comprehensive revision of the 2026 US bond supply forecast by major Wall Street banks, and promoted a general decline in short-term borrowing costs. In addition to the new reserve management operation (RMP), the Federal Reserve will also reinvest about 14.4 billion US dollars in treasury bonds through institutional debt maturity in December to further strengthen support for the capital market.

The Zhitong Finance App learned that after the announcement of the operation, Barclays drastically raised the Federal Reserve's 2026 treasury bill purchase scale forecast, believing that the cumulative annual debt purchases may be close to 525 billion US dollars, higher than the previous estimate of 345 billion US dollars. The net supply available to private investors will also fall from the expected $400 billion to just $220 billion.

J.P. Morgan also raised its forecast. It is expected that the Federal Reserve will maintain a monthly purchase rate of 40 billion US dollars until mid-April next year, then drop to 20 billion US dollars per month. In addition to MBS repayment and further investment, the total purchase volume in 2026 will be close to 490 billion US dollars, almost doubling. TD Securities expects the Federal Reserve to buy 425 billion US dollars of treasury bonds to absorb almost all of the net supply; Bank of America believes that in order to make up the reserves needed by the market, the Federal Reserve may be forced to “maintain intensive debt purchases for a longer period of time.” If treasury securities investors are squeezed, the Federal Reserve may even expand the scope of purchases to short-term securities with a term of less than three years.

Investment banks generally believe that this move by the Federal Reserve will effectively ease reserve constraints caused by downsizing, help reduce pressure on short-term financing, and boost short-term swap spreads, which will benefit SOFFR-federal funds spread trading and front-end basis trading. Short-term interest rate futures trading volume surged on Wednesday, and the two-year swap spread widened to a new high since April, indicating that market tension has abated.

The strategist also pointed out that the Federal Reserve is managing the stage where reserves return to an “adequate” level more carefully than in 2019, showing a strong intention to avoid disorder in the capital market. Some institutions, such as RBC, believe that this move is “more like absorbing the Treasury's circulation,” and that the Federal Reserve and the Treasury are actually jointly dealing with the same issues in the capital market.

Although the liquidity environment will improve, many institutions warn that capital market fluctuations at the end of the year will still be unavoidable. CIBC pointed out that the scale of debt purchases in December was still insufficient to cover overnight capital requirements at the end of the quarter, because banks usually shrink their balance sheets at the end of the year, leading to tighter liquidity in the repurchase market. Wells Fargo also said that although the active operation of the Federal Reserve can make the market “less volatile,” it is not a panacea; financial pressure will still exist in the short term.

According to an analysis by SMBC Nikko Securities, if bank reserves are pushed to more than 3 trillion US dollars by the end of January next year, the SOFR interest rate will be closer to the reserve interest rate (IORB), and the federal funds rate may fall by about two basis points as a result. However, the effectiveness of this strategy still depends on market participants' willingness to use permanent repurchase facilitation tools (SRF).

As the Federal Reserve officially stopped reducing institutional debt and MBS holdings in December and re-expanded treasury bond holdings through reinvestment and reserve management operations, the capital market entered a new stage of shifting from “downsizing” to “supplementary reserves.” Against the backdrop of the US Treasury increasing its debt issuance efforts and short-term interest rates becoming more sensitive to funding conditions, the Fed's operation is becoming a key variable in the 2026 US bond supply balance and short-term interest rate trends.