JPMorgan Chase & Co. says the money-market stress that sentshort-term borrowing rates surging last month is likely toget much worse despite the Federal Reserve's attempts to injectbillions of dollars into the financial system.

The Fed has offered overnight loans and started buying up to $60billion of U.S. Treasury bills a month in an effort to easepressure in the vast repo market, where bankstypically lend their assets in exchange for short-term financing.Secured lending rates shot up in late September, with analystspointing to scarcity of interbank reserves as well as regulationsthat limit the size of bank balance sheets and their repo-lendingcapacity as the potential culprits.

JPMorgan says it's not convinced the Fed has resolved the issuesin the funding markets, according to a note from analysts led byJoshua Younger in New York. Funding pressures resurfaced last weekeven after primary dealers—firms approved to trade directly withthe Fed—took all of the available overnight liquidity from thecentral bank and sold it as many T-bills as possible.

"Given the benefits of our newfound perspective, we recommendviewing these moves as highlighting the limitations of the Fed'schosen solution to their operational issues," the analysts wrote."With year-end coming up, this is all likely to get much worse, inour view, before it gets better."

The rate for overnight loans secured by general collateral firsttraded at 1.93% / 1.92% on Monday—an improvement from last week,when it traded at levels slightly over 2%.

The overnight liquidity provided by the Fed goes directly toprimary dealers, whereas those most in need of it are thenon-primary dealers, the JPMorgan analysts wrote. The success ofthe program therefore depends on how much of the liquidity ispassed along, but primary dealers are deterred from doing so byrules specifying how much capital they must hold to protect againstlosses.

Meanwhile, a preliminary analysis of balance sheets at thelargest banks based on their third-quarter results suggests theymay have to cut back on repo activity even more at year-end toavoid liquidity charges.

"What new permanent reserves are being delivered to the bankingsystem should face the same frictions—both from balance sheetconstraints and intraday liquidity requirements—that generatedthese issues in the first place," the JPMorgan analysts said.

JPMorgan's note follows similar warnings from Bank of AmericaMerrill Lynch and Goldman Sachs Group Inc., who have alsoattributed September's funding stresses to factors includingpost-financial crisis bank regulation. Even after the Fed's latestmoves to ease the logjam in funding markets, "intermediationbottlenecks remain," Goldman Sachs said.

Analysts at sell-side banks have argued for the creation of a"standing repofacility" by the Fed that would allow banks to continuouslyexchange their securities with the central bank in exchange forcash. Meanwhile, JPMorgan CEO Jamie Dimon said his bank—still oneof the biggest players in the repo market—was unable to calm, orprofit from, the dislocation in funding markets last month becauseof regulation.

The JPMorgan analysts recommend investors use futures markets toposition for the spread between the Fed funds rate and repo towiden in December, as this will capture year-end funding stress.This has been a popular way for traders to play the fundingsqueeze, with a surge in activity in these contracts seen followingSeptember's repo spike.

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