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Ripples in the Reserve Pool: Unveiling Liquidity Signals from the Federal Funds Market

  • New research by Anbil, Infante, & Senyuz (2026) indicates the fed funds market retains diagnostic value despite the ample-reserves framework.
  • Lending between domestic banks reveals real-time signals about distributional frictions, whereas non-bank arbitrage trades provide limited insight into bank liquidity.
  • Domestic bank-to-bank lending acts as an early warning system for liquidity stress, even when aggregate reserves appear sufficient.
  • The fed funds market's role as a liquidity barometer is expected to strengthen if the banking system enters an environment with fewer reserves.
  • Prior to 2008, the market was central to monetary policy implementation under scarce reserves; post-crisis, trading volumes declined & participant composition shifted.
  • Federal Home Loan Banks (FHLBs) now dominate lending (>90%) because they cannot earn interest on excess reserves (IORB).
  • U.S. branches of foreign banks account for ~90% of borrowing, primarily engaging in arbitrage ("Fed arb") by borrowing below IORB.
  • Domestic banks borrow intermittently for genuine liquidity management, often paying spreads near or above IORB.
  • Small domestic banks (<$10B assets) exhibit higher sensitivity to deposit fluctuations & maintain tighter reserve-to-deposit ratios than large banks.
  • Non-bank lenders supply reserves elastically with stable rates, while bank lenders supply inelastically & charge higher rates when liquidity tightens.
  • Bank lender supply elasticity increases as aggregate reserves decline, making them the primary drivers of price sensitivity in tight liquidity conditions.
  • Bankers' banks serve as key intermediaries for smaller institutions, with their reserve positions strongly correlated with spreads charged by bank lenders.
  • Aggregate measures like the effective federal funds rate mask distributional frictions, necessitating granular data to assess true liquidity conditions.
  • Monitoring the fed funds market remains essential for policymakers to understand financial conditions & ensure effective monetary policy transmission.