January 27th saw daily borrowing in federal funds climbs to $120 billion, the highest it has been since 2016. This was a marked increase from the $113 billion previously reported from the last session.

Analysts say that the grim combination of federal rate hikes and quantitative tightening is what spurred depositors to shift from savings to money market funds and other high-yielding banking products. As a result, banks are scrambling to find new sources of funding.

This is a stark contrast to banking activity at the height of the pandemic when monetary stimuli and other fiscal measures led to a lot of money being released.

A Lesson on the Impact of Extreme Measures

TD Securities senior US rates strategist Gennadiy Goldberg opines that the tightening of financial conditions and the consequent rise of funding costs have both been extreme, with rate hikes coming in at their fastest since the economic crisis of the 1980s. But while this resulted in major deposit outflows, it has not as yet driven a funding crunch.

For now, the Fed is setting its sights on the federal funds market’s overnight unsecured loan rate as far as its monetary policy decisions are concerned. This is currently pegged at 4.33% and investors are expecting the Fed to increase it by another quarter point as it closes its two-day policy meeting in Washington on Wednesday, February 1st.

Meanwhile, the results of a recent Fed survey have given hints on the strategies banks may be implemented in the face of mounting funding pressures. Several financial firms say that they planned to borrow from unsecured funding markets, issue certificates of deposit, or even raise brokered deposits in the event that their reserves dropped to worrying levels. Likewise, most banks in the United States replied that they were likely to borrow an advance from Federal Home Loan Banks if their reserves hit dire levels.

As borrowers, domestic banks are rapidly becoming the majority when it comes to participating in fed funds, as their share of market borrowings recently shot up to 25% compared to the 5% reported in 2021. According to Barclays money market strategist Joseph Abate, domestic banks will only borrow in the fed funds market if their intraday liquidity buffers decrease considerably. Otherwise, if bank reserves remain in the black, then there is a much lower domestic bank share in terms of fed funds borrowing.