Wall Street Divided on U.S. Funding Market Ease Amid Rising Rates

Wall Street strategists are divided over whether the U.S. funding market will ease in the coming months, primarily due to the recent volatility in overnight borrowing costs. A combination of factors is driving up short-term rates, including the U.S. Treasury's issuance of more short-term debt to rebuild its cash reserves, the Federal Reserve's reduction of its balance sheet, and the near-zero usage of the central bank's key overnight lending tool.

These pressures have investors on edge about the sharp rise in borrowing costs. Particularly concerning is the possibility that the Secured Overnight Financing Rate (SOFR) could rise further in the coming months, with disagreements over whether funding costs will ease. Since late August, the SOFR benchmark rate has been higher than the Federal Reserve's target rate.

On September 12, JPMorgan and Citigroup presented opposing views and recommended contrasting trading strategies. JPMorgan believes investors have overestimated the risk of rising funding costs, while Citigroup expects the current situation to persist until the end of 2025.

JPMorgan's team, led by Teresa Ho, predicts that overnight rates will ease by the end of the year. They advise traders to buy December SOFR futures while selling an equivalent amount of federal funds futures. They expect the spread between SOFR (currently at 4.42%) and the 30-day federal funds rate (currently at 4.33%) to narrow in the last month of 2025. In the December futures market, this spread is currently around -7.5 basis points.

JPMorgan argues that bank reserves are not scarce and that the Federal Reserve's Standing Repo Facility (SRF), which allows eligible institutions to borrow cash against collateral at the policy target rate, is a crucial liquidity backstop. They also note that the Treasury's large issuance of bills following the resolution of the debt ceiling issue this year will slow down.

In a report, Ho stated, "We do not believe the recent rise in SOFR reflects an imminent liquidity event and expect banks to deploy reserves at the appropriate time."

Meanwhile, Citigroup's strategists, led by Jason Williams, believe that funding costs will remain high until the end of the year. They recommend shorting December SOFR contracts relative to federal funds rates, predicting that SOFR will be about 4-5 basis points higher than federal funds rates on "good days," with its fair value closer to -10 basis points.

Williams wrote in a report, "We do expect to see SOFR gradually rise over the next few months. According to guidance from the Treasury's August refinancing meeting, they will increase the size of some Treasury auctions in October, and we expect reserves to continue to decline."

BI strategists Will Hoffman and Ira Jersey noted, "While much of the net issuance following the debt ceiling has already passed, the most severe funding pressures are yet to come—the Federal Reserve's comfort zone for market-driven reserve scarcity may be tested."

JPMorgan and Citigroup are not the only banks with differing views. Last week, Barclays exited a position buying the September SOFR spread relative to federal funds, which was established just a month ago. The bank cited upward pressure on funding costs as a potential "new default setting" for the market as it approaches the quarter-end.

At Morgan Stanley, strategists maintain that the market will ease as soon as next month. They advise going long on the October 2025 SOFR spread relative to federal funds, believing that bank reserves remain ample. On Monday, Bank of America closed a short position on the same tenor, stating that the spread is "near fair value pricing." Analysts led by Mark Cabana now recommend going long on the January 2026 SOFR spread relative to federal funds, suggesting that federal funds rates may gradually rise within their target range early next year.

Despite their differences, JPMorgan and Citigroup agree on one point: the situation from September 2019, when funding costs surged and the Federal Reserve injected hundreds of billions of dollars into the funding market, is unlikely to repeat.