The Federal Reserve Building | Photo credit: Joshua Roberts
In its defense, the Fed emphasizes that this liquidity injection was necessary to ensure that the Fed Funds rate remains within the target range. While this move may come as a surprise to many, readers of this column will be aware that we have mentioned several times in recent weeks that liquidity has tightened in the US and that this was also a factor driving the correction in assets such as cryptos and some overvalued AI stocks. As a result of this tightening, the target range of the Fed Funds rate was tested in the market as financial institutions in need of liquidity were unable to borrow within the target range. Interest rates across the economy are set based on the target range, and if it is exceeded it could impact the Fed’s targets.
In September 2019, the US financial system experienced a repo market crisis, when the repo rate on transactions between financial institutions for liquidity management rose significantly above the Fed Funds rate. While the fed funds rate is the rate at which banks borrow from each other (usually unsecured), the repo rate is the rate at which a broader group of financial institutions borrow from each other using high-quality collateral. Since the repo transactions are backed by high-quality collateral, the Fed Funds rate is expected to be very closely monitored. However, when there was an unexpected tightening of liquidity in the US in September 2019 due to withdrawals of deposits for tax payments, large Treasury issuances and some other factors, it resulted in instances where overnight rates rose as high as 10% in short cases, while the Fed Funds rate ceiling at the time was 2.5 percent.
Therefore, the reserve management or QE (whatever you want to call it) that the US Fed is now implementing is intended to ensure an ample reserve regime, as the signals about the tightening of liquidity now gave the atmosphere of September 2019.
Soon after, there were views that this liquidity injection would be positive for the Indian markets in terms of FII flows, but that may be an over-simplistic view and probably incorrect. For example, if you look at the data on FII flows since the Fed’s decision, the selling has continued. Second, US 10-year yields have continued to rise after an initial decline
Post the Fed’s decision. At the current level of around 4.15 percent, risk-free bonds will continue to provide competition to high-cost Indian markets from an FII perspective.
Published on December 16, 2025
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