Taking substantial action at this point, though, would send what could be a negative message to the market — that the balance sheet runoff, which former Chair Janet Yellen said would be "like watching paint dry," is running into snags and requires corrective action.
However, the Fed would have no choice if there are indications that it can't control the market movements, particularly considering the record level of Treasury debt the government has issued this year.
"This is exposing how tenuous that process is and the great unknown of what's going to happen," said Danielle DiMartino Booth, founder of economic consulting firm Money Strong and a former advisor to former Dallas Fed President Richard Fisher for nine years, including during the financial crisis. "These are plumbing issues that are coming back to haunt the Fed."
The flood of debt issuance combined with rate hikes and the balance sheet runoff is creating a tightening in financial conditions that the Fed may not have anticipated.
While Powell and others have touted the strength of the economy as justification for raising rates, the yield curve compression is signaling to some market participants that a slowdown may not be that far in the distance. An inverted yield curve, in which longer-term yields are lower than short-term, indicate that markets believe growth will be slower in the future.
"There are a lot of things going on right now, none of which are favorable for the Fed trying to create a perception that they've got everything under control," DiMartino Booth said.
Other issues also are at play in terms of the funds rate closing in on the IOER level.
Smaller banks "have been much more aggressive" in expanding lending than large banks, causing them to have to borrow from bigger institutions. That is creating most of the demand in the short-term funds market as big banks already have nearly $2 trillion in reserves at the Fed. That in turn is driving the funds rate higher, said Steve Blitz, chief U.S. economist at TS Lombard.
Blitz said there remains some confusion about how high the level of reserves needs to be at the Fed, creating uncertainty about how far the Fed should go in tightening.
As for the effort to keep the funds rate in check, "it doesn't seem to be working," he added.
Whalen suggested the Fed should revisit a process known as "Operation Twist" that it conducted amid the bond buying. The Fed in that instance bought long-term holdings and sold an approximately equal amount of shorter-term Treasurys in an order to drive down rates farther out on the curve. Whalen said the Fed should reverse that process this time to keep shorter-term rates low, without expanding the size of its balance sheet.
Whether the Fed would be willing to do such an about-face at this stage, though, is in doubt.
"You're talking about a massive reversal of position," DiMartino Booth said. "I think that would send a very bad signal for markets."
Correction: An earlier version misstated how Operation Twist worked.