Despite the Fed keeping rates elevated at 5.25–5.50%, financial...
EndGame Macro@onechancefreedm
16 views
Jul 24, 2025
~2 min read
Advertisement
1
Despite the Fed keeping rates elevated at 5.25–5.50%, financial conditions have eased all the way back to levels we last saw when rates were near zero and the Fed was still doing quantitative easing. That’s not supposed to happen. Higher rates are meant to tighten financial conditions, making credit more expensive and slowing the economy. But in practice, the plumbing of the system is short circuiting that mechanism.
So why is this happening? A few key reasons.
First, the U.S. Treasury has front loaded a massive amount of bill issuance into short-duration maturities T-bills which are being soaked up by money market funds that are flush with cash. The RRP (reverse repo) facility has been drained since mid-2023, and that capital is being recycled into T-bills, keeping front end funding extremely liquid despite high nominal rates.
Second, the banking system still has excess reserves north of $3 trillion. That liquidity hasn’t really left. So while the Fed has stopped expanding its balance sheet, it hasn’t meaningfully drained the system either. The banking sector isn’t under significant funding pressure, which means lending capacity, while tighter than 2021 is still functioning.
Third, corporate bond spreads remain narrow, high yield issuance is quietly ramping back up, and equity markets, especially the S&P 500 have surged, lifting household wealth and easing credit access via capital markets. In short: financial conditions aren’t just about the Fed Funds Rate; they reflect market based conditions for risk taking, credit issuance, and liquidity.
Ironically, this easing of financial conditions may another reason why the Fed hasn’t cut yet. If Powell were to cut prematurely, it could further loosen conditions, risk reigniting inflation, and undermine credibility. But if the Fed keeps rates too high for too long and the underlying economy weakens beneath the surface, especially with rising delinquencies in auto loans, credit cards, and softening labor data, we could suddenly flip into hard tightening via credit events or default cycles.
So we’re in a bizarre place where the Fed’s hiking cycle is still technically in place, but the market has effectively eased around it. It’s like monetary policy is stuck in a tug of war between its formal settings (high rates) and its actual effects (easing conditions). If this divergence persists, it risks blunting the Fed’s toolkit just when it may need it most. The longer rates stay high without tightening financial conditions meaningfully, the greater the odds that when the break comes, it’s sharp, because all the buildup of leverage, positioning, and complacency didn’t adjust the way policy was designed to.
This chart is a flashing signal that the macro plumbing isn’t behaving like it used to. And that usually ends one of two ways: either a sudden policy reversal, or a market event that does the tightening the Fed couldn’t.
x.com/HappyKitty4U/s…
So why is this happening? A few key reasons.
First, the U.S. Treasury has front loaded a massive amount of bill issuance into short-duration maturities T-bills which are being soaked up by money market funds that are flush with cash. The RRP (reverse repo) facility has been drained since mid-2023, and that capital is being recycled into T-bills, keeping front end funding extremely liquid despite high nominal rates.
Second, the banking system still has excess reserves north of $3 trillion. That liquidity hasn’t really left. So while the Fed has stopped expanding its balance sheet, it hasn’t meaningfully drained the system either. The banking sector isn’t under significant funding pressure, which means lending capacity, while tighter than 2021 is still functioning.
Third, corporate bond spreads remain narrow, high yield issuance is quietly ramping back up, and equity markets, especially the S&P 500 have surged, lifting household wealth and easing credit access via capital markets. In short: financial conditions aren’t just about the Fed Funds Rate; they reflect market based conditions for risk taking, credit issuance, and liquidity.
Ironically, this easing of financial conditions may another reason why the Fed hasn’t cut yet. If Powell were to cut prematurely, it could further loosen conditions, risk reigniting inflation, and undermine credibility. But if the Fed keeps rates too high for too long and the underlying economy weakens beneath the surface, especially with rising delinquencies in auto loans, credit cards, and softening labor data, we could suddenly flip into hard tightening via credit events or default cycles.
So we’re in a bizarre place where the Fed’s hiking cycle is still technically in place, but the market has effectively eased around it. It’s like monetary policy is stuck in a tug of war between its formal settings (high rates) and its actual effects (easing conditions). If this divergence persists, it risks blunting the Fed’s toolkit just when it may need it most. The longer rates stay high without tightening financial conditions meaningfully, the greater the odds that when the break comes, it’s sharp, because all the buildup of leverage, positioning, and complacency didn’t adjust the way policy was designed to.
This chart is a flashing signal that the macro plumbing isn’t behaving like it used to. And that usually ends one of two ways: either a sudden policy reversal, or a market event that does the tightening the Fed couldn’t.
x.com/HappyKitty4U/s…