Liquidity pressures in short-term funding markets have eased this month, with borrowing rates settling into more normal territory after drastic actions taken by the Federal Reserve.

The central bank has injected massive amounts of cash into the financial system since mid-March, when the coronavirus pandemic led to a sharp downturn in financial markets and shook investor confidence. The shock made investors warier of lending money to others, making short-term borrowing much more expensive for many companies and municipal securities issuers.

But short-term borrowing rates have come down since, an indication that the Fed's programs "seem to be working," analysts at Société Générale wrote in a note to clients.

In one such sign, the rate on the 3-month USD London interbank offered rate, which represents the rate that banks are willing to lend to each other over three months, fell to 1.10% on April 20. That is down from a high of 1.45% on March 27.

The decline in Libor has occurred as a new Fed facility aimed at easing strains in short-term funding markets came online last week. The Commercial Paper Funding Facility, which the central bank had announced last month, officially began purchasing short-term debt from highly rated issuers on April 14.

The commercial paper market is critical to the U.S. financial system; many large firms and some municipal securities issuers use it to issue short-term debt in exchange for cash, which they can then use to meet payroll and other short-term liabilities.

The Fed has been offering to buy three-month commercial paper from highly rated corporate and municipal issuers. The holdings at the facility rose to $974 million as of April 15, according to the Fed's weekly balance sheet update.

The announcement of the facility has helped bring rates down even for slightly lower-rated firms that the Fed is not directly helping, a trend that accelerated once the facility got up and running. One-day borrowing rates for nonfinancial firms rated A2/P2 dropped to 0.87% on April 17, down from an average of 3.22% for the week of March 20, according to data on the Fed's website.

New York Fed President John Williams highlighted the easing of liquidity conditions during an April 16 speech, saying the central bank's actions "averted a potential shutdown in the flow of credit and are providing funding and stability at a time of extraordinary volatility in markets."

"Although stresses in financial markets will not entirely abate until the pandemic is behind us, we have seen material improvements in measures of liquidity and market functioning in key parts of the U.S. financial system," Williams said.

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In another sign of reduced stress, volatility in the market for U.S. Treasurys has declined substantially, prompting the Fed to dial back its Treasury purchases. The New York Fed, whose trading desk implements the Fed's monetary policy strategy, plans to buy $75 billion in Treasury securities this week, down from $200 billion two weeks ago.

"Volatility has come down quite a bit in that market, which I think is a good thing from the Fed's perspective," said Greg Faranello, head of U.S. rates at AmeriVet Securities. "We've seen this really across the board."

The asset purchases have helped bring the Fed's balance sheet to record highs, with its total assets rising to approximately $6.4 trillion. They also have flooded the Fed's primary dealers with cash — to the point where some now appear to be returning cash to the Fed in exchange for Treasury securities through what are known as reverse repo operations.

"Amid the initial success of providing liquidity into the credit markets, the Fed has oversupplied bank reserves," Kathy Bostjancic, chief U.S. financial economist at Oxford Economics, wrote in a research note.

The excess reserves in the banking system have put downward pressure on the Fed's benchmark interest rate, which has traded at an average of 0.05% in recent days. That is at the lower end of the central bank's current 25-point target range of 0% to 0.25%, raising the risk that the fed funds rate could fall out of that range.

To nudge the fed funds rate back to the middle of the range, the Fed may soon raise the interest rate it pays banks for their excess reserves and the rate on the overnight reverse repo operations by perhaps 5 to 10 basis points, Bostjancic wrote. The Fed has made this technical move several times in the past couple of years.

"These rate increases would be technical in nature, not a fundamental tightening of policy," Bostjancic wrote.