Fed December Rate Cuts 2025: Why Powell and Liquidity Constraints Make Cuts Unlikely

Welcome to TMS Capital Research. We track liquidity - the stuff that actually moves markets while everyone else watches headlines. This is our first piece. Let's get into it.

Markets are pricing in a coin flip for December rate cuts. They're wrong.

Chair Powell wasn't being coy when he said a December cut is "not a foregone conclusion - far from it." He meant it. But the market heard "we're data dependent" when he actually said "we're liquidity constrained."

Big difference.

The real story: The Fed's emergency liquidity valve is empty. Bank reserves are scraping minimum levels. The plumbing that kept everything smooth for three years is gone. And Powell can't cut rates into this mess without risking a September 2019-style repo blowup.

The trade: Long 3-month T-bills, short Fed Funds futures. Target 15-20 bps. Because when the market reprices this, it's going to hurt.

Let's dig into why the Fed's hands are tied.

Quick vocabulary lesson for those new here:

Overnight Reverse Repo Facility (RRP) = The Fed's overflow parking lot for excess cash. When money market funds have too much money and nowhere to put it, they park it here overnight at a fixed rate.

Why it matters: It acts like a shock absorber for the financial system. Too much cash sloshing around? RRP soaks it up. Interest rates threatening to collapse? RRP provides a floor.

The problem: That shock absorber just disappeared.

The RRP peaked above $2.5 trillion in 2023 - more money than the GDP of France sitting at the Fed every single night.

As of this week? $342 billion.

Where'd it go? Treasury bills. Money market funds looked at earning 3.75% at the RRP versus 3.95% in T-bills and made the obvious choice. Can't blame them - that's rational capital allocation.

But here's the thing: when that $2.5 trillion was sitting in the RRP, the Fed had cushion. They could cut rates, shake things up, and if anything broke, the RRP would absorb the shock.

Now there's no cushion. Every liquidity hiccup, every funding squeeze, every quarter-end scramble falls directly on bank reserves. And bank reserves are already running low.

The Fed estimates bank reserves at around $2.88 trillion as of early November. Sounds like a lot, right?

That's approaching what the Fed calls the "ample" threshold - the amount needed to keep monetary policy working smoothly.

How do we know we're close? Check the tri-party general collateral rate (TGCR) - the cleanest measure of repo market conditions. It's been trading above the interest rate on reserves since September.

Translation: Funding markets are already tight. Banks are scrambling for reserves. The plumbing is creaking.

This is exactly what happened in September 2019 right before overnight repo rates spiked to 10% and the Fed had to emergency inject liquidity.

The Fed remembers. That's why they ended balance sheet runoff (QT) on December 1st. Not because they wanted to. Because they had to.

Let's go to the transcript from October 29th:

Powell: "A further reduction in the policy rate at the December meeting is not a foregone conclusion - far from it."

Market reaction: "Yeah but you'll probably cut anyway, lol"

Then Boston Fed President Susan Collins delivered what CNBC called an "uncharacteristically blunt assessment" this week, basically saying "we're flying blind on data because of the government shutdown, and we're not cutting rates blind."

Market reaction: Fed Funds futures dropped from 95% probability of a cut to 50%.

Still too high.

Here's what they're missing: Even if inflation moderates and unemployment ticks up, the Fed cannot cut rates when reserves are this low. It's not about data dependence - it's about not breaking the financial system.

You can't ease monetary policy into a funding crisis. Ask the Bank of England how that worked in September 2022 (spoiler: not great).

Here's the flow that's tightening liquidity:

Step 1: T-bills yield 3.95%, RRP yields 3.75%

Step 2: Money market funds rotate $2.5 trillion out of RRP into bills

Step 3: That money now finances the Treasury deficit instead of sitting at the Fed

Step 4: The Fed's liability buffer shrinks

Step 5: Bank reserves become the only cushion

Step 6: Treasury keeps issuing bills (deficit is 6%+ of GDP)

Step 7: Money keeps flowing to bills, not back to Fed

Step 8: Reserves keep falling

This isn't reversing. The structural bid for T-bills is stronger than the Fed's ability to supply reserves without restarting QE (which they won't do with inflation still elevated).

The liquidity tightening is one-way.

Quick detour into geopolitics, because it matters:

Japan holds $1.1 trillion in U.S. Treasuries - the largest foreign holder. Japanese Government Bond (JGB) yields are rising as the Bank of Japan normalizes policy. At some point, Japanese institutions might decide domestic yields are attractive enough to bring money home.

Even a modest reduction in Japanese Treasury holdings - say, 10-15% - means an extra $110-165 billion that domestic markets have to absorb.

Who absorbs it? Money market funds. Who are already fully deployed in bills because yields are attractive.

Result: Either bill yields spike (good for our trade), or the Fed has to intervene (which they can't afford to do with reserves this low).

Either way, it tightens conditions further.

Markets still price ~50% odds of a December cut. We think it's 15-20% max.

Long: 3-month Treasury bills (currently ~3.95% yield)

Short: Fed Funds futures December contract (implied rate ~3.775%)

If the Fed holds in December (our base case), fed funds stay at 3.875% (midpoint of 3.75-4.00% range). Meanwhile:

Heavy Treasury issuance continues through year-end

MMFs keep preferring bills over RRP

Tight reserve conditions support elevated short-term rates

Bill yields hold steady at 3.95%

As the market reprices December cut odds lower, futures adjust up, bills hold firm. You capture the spread.

Currently:

T-bills: 3.95%

Fed Funds futures imply: 3.775%

Spread: 17.5 bps

Target (post-reprice):

T-bills: 4.25-4.35%

Fed Funds futures imply: 3.875% (no cut priced)

Spread: 37.5-47.5 bps

You capture: 20-30 bps as convergence happens

Exit if: December cut odds move back above 70% (unlikely but possible with severe data deterioration)

Stop: 10 bps against you

Size: 1-2% of capital - this is tactical, not structural

Timeline: Now through December 10th (FOMC decision day)

What Could Go Wrong:

Fed cuts anyway despite liquidity concerns

Major financial stress forces emergency action (would be bullish for bills anyway)

Data collapses so hard the Fed prioritizes growth over plumbing (watch initial claims)

SOFR vs Interest on Reserves: If SOFR trades >10 bps above IORB, liquidity is too tight

TGCR (Tri-party General Collateral Rate): Already elevated, watching for further widening

Fed Funds futures: Repricing in real-time as reality sets in

3-month bill yields: Should stay firm given issuance calendar

Fed H.4.1 Balance Sheet (Thursdays at 4:30pm ET): Reserve levels, RRP balances

Treasury auction results: Bill auctions showing strong demand = our thesis playing out

November CPI (Dec 11): Comes out after the FOMC meeting, so won't influence December decision

PCE inflation (Nov 27): Fed's preferred metric - if this spikes, cements no-cut

Quarter-end (Dec 31): Repo rate action will be telling for H1 2026

We're not just calling one FOMC meeting. We're identifying a regime shift.

2021-2023: Abundant liquidity, massive RRP, Fed could ease/tighten without worrying about plumbing

2024-2025: Transition - RRP draining, reserves approaching ample, Fed increasingly constrained

2026+: New normal - Ample reserves regime, Fed has to manage rate policy AND balance sheet carefully

What this means:

Rate cut cycles will be shallower than pre-2008

Money market volatility will be higher and more persistent

Treasury term premium will be structurally elevated

Liquidity risk becomes a tradeable factor again

The December meeting is just the first time markets realize the rules changed.

There will be others.

Most macro analysis focuses on:

Inflation prints

Payroll numbers

Fed dot plots

GDP forecasts

All important. All secondary.

The primary driver is liquidity.

You can have perfect CPI data, perfect employment data, perfect GDP - but if the plumbing doesn't work, none of it matters.

September 2019 proved this. Repo rates spiked to 10% overnight despite zero economic stress. Why? Reserves were too low. The Fed had to inject $75 billion in emergency liquidity within 24 hours.

We're approaching that threshold again. The Fed knows it. That's why Powell wasn't being cute about December - he was being honest.

Markets just haven't figured it out yet.

That's where we come in.

Beyond the specific T-bill/Fed Funds setup, there's a broader positioning shift happening:

Cash is an asset class again.

For the first time since 2019, you can earn positive real yields in T-bills. 3.95% yield with inflation trending toward 2.5-3.0% = actual returns.

This isn't "sitting on the sidelines." It's intelligent capital allocation while you wait for better opportunities.

In the 2020-2023 era, cash was trash. You had to be deployed in something, anything, to avoid getting crushed by negative real rates.

That era is over.

Now you can:

Earn real yield in bills

Maintain full liquidity

Wait for quality opportunities

Not panic into overvalued assets

The liquidity regime shift makes patience profitable again.

The market is slow to recognize regime changes. They always are.

Everyone's still trading with the 2020-2023 playbook where the Fed had unlimited flexibility and liquidity was free. That world doesn't exist anymore.

The new playbook:

Watch plumbing, not just data

Understand reserve dynamics

Trade liquidity constraints as a real factor

Don't fight the Fed when they're actually being honest about constraints

Powell told you December isn't guaranteed. The liquidity data confirms it. The trade is there.

Take it.

This is TMS Capital Research. We publish liquidity-driven macro analysis and actionable trade ideas. No fluff, no permabear doom, just the signals that actually matter.

Subscribe to get our next piece on global liquidity regime shifts and why 2026 looks nothing like the last three years.

Federal Reserve H.4.1 Weekly Balance Sheet

FOMC Statements and Press Conference Transcripts

CNBC Fed coverage (November 2025)

New York Fed daily repo market data

CME FedWatch Tool

Charles Schwab Fed meeting analysis

NY Fed speeches (Perli, Logan, Williams)

Disclaimer: This is analysis and commentary, not investment advice. Trading involves risk of loss. Markets can stay irrational longer than you can stay solvent. Size appropriately, use stops, and don't bet the farm on any single trade. We're sharing what we see - you're responsible for what you do with it.

Based on current liquidity constraints, with RRP at $342 billion (down from $2.5 trillion) and bank reserves at $2.88 trillion approaching the "ample" threshold, the probability of a December 2025 Fed rate cut is approximately 15-20%, significantly lower than the 50% currently priced by markets.

The Overnight Reverse Repo Facility is the Fed's mechanism for absorbing excess liquidity from the financial system. Money market funds park cash at the Fed overnight at a fixed rate of 3.75%. The RRP has declined from $2.5 trillion in 2023 to $342 billion in November 2025 as funds rotated into higher-yielding Treasury bills at 3.95%.

Bank reserves represent the Fed's primary liquidity cushion. At $2.88 trillion, reserves are approaching the "ample" threshold - the minimum needed for smooth monetary policy operations. Below this level, the Fed loses flexibility to cut rates without risking repo market disruptions similar to September 2019, when overnight rates spiked to 10%.

The trade involves going long 3-month Treasury bills (yielding ~3.95%) and short Fed Funds futures (implied rate ~3.775%). The current spread of 17.5 basis points should widen to 37.5-47.5 bps as markets reprice the lower probability of December rate cuts, targeting 20-30 basis points of return.

Key daily metrics include SOFR vs Interest on Reserves (watch for >10 bps spread), TGCR (Tri-party General Collateral Rate), and Fed Funds futures. Weekly data to track includes the Fed H.4.1 Balance Sheet (released Thursdays at 4:30pm ET showing reserve and RRP levels) and Treasury auction results.

The RRP facility declined from over $2.5 trillion in 2023 to $342 billion by November 2025. Money market funds rotated out of the RRP (yielding 3.75%) into Treasury bills (yielding 3.95%) for better returns. This 20-basis-point yield differential drove the $2+ trillion outflow, removing a critical liquidity cushion from the financial system.