Wall Street strategists are deeply divided over the direction of the U.S. funding market in the coming months, a divergence largely driven by recent heightened volatility in overnight funding costs. Multiple factors have collectively pushed up ultra-short-term rates, including the U.S. Treasury’s increased issuance of short-term bills to rebuild its cash reserves, the Federal Reserve’s ongoing reduction of its balance sheet, and a sharp decline in the usage of the central bank’s key overnight lending facility to near zero. These pressures have kept the market on high alert for a potential sharp rise in borrowing costs, with investors particularly concerned that the Secured Overnight Financing Rate (SOFR) could climb further. Since late August, SOFR has consistently remained above the Fed’s policy target rate, adding to market uncertainty.
Against this backdrop, J.P. Morgan and Citigroup presented opposing views on September 12 and recommended contrasting trading strategies. J.P. Morgan believes the market is overestimating the upside risks to funding costs. Analysts led by Teresa Ho expect overnight rates to ease by year-end and recommend buying December SOFR futures while selling an equivalent amount of federal funds futures. In contrast, a team of strategists at Citigroup led by Jason Williams holds the opposite view, anticipating that funding costs will remain elevated through the end of the year and advising clients to short December SOFR contracts.
Beyond these two institutions, other banks have also expressed varying opinions. Barclays recently exited a long SOFR spread position established just a month ago, noting that upward pressure on funding costs could become the new normal for the market. Morgan Stanley remains relatively optimistic, with strategists predicting that relief could come as early as next month. They recommend going long on the October 2025 SOFR spread, arguing that bank reserves remain ample.
Despite their opposing views, J.P. Morgan and Citigroup agree on one key point: a repeat of the September 2019 liquidity crisis is unlikely. Back then, a sharp spike in funding costs forced the Fed to inject tens of billions of dollars into the market. While divisions are significant today, most institutions believe systemic risks remain controllable, with market volatility more likely stemming from short-term technical factors rather than deep-seated liquidity issues.
