Friday 16 June 2023

Jerome and Janet's impending liquidity rug pull


If the last 3 months have mainly been about circa $700bn being injected into banks and $500bn being pulled from bank deposits and some of that deposit pull going into various financial markets, the coming summer period looks set to be more or less the opposite. 

Consider the following:

  • Yellen will raise up to $1tn TGA and is issuing net about $250bn/ qtr.
  • Powell is doing about $300bn QT/ qtr
  • And he wants to run off the funding expansion this year, they have run off $200bn SOFR based funding MTD
  • And have another $400bn SOFR based funding YTD to go
  • There is about $3.3tn excess reserves at the Fed
So they could drop excess reserves to about $1.4tn by the end of September
There is about $2Tn sitting in reverse repo, which is effectively QE sterilisation, but it may be the case that if the Fed encourages/ forces some of that out, the released money goes into excess reserves and not into Treasuries. Although some is likely to go into Tsys and soften the impact of the above. 
Minimum excess reserves in the system is probably around $1tn, as bank finance needs and deposits are not evenly spread, with Treasury primary dealers being the main net wholesale borrowers from banks.
A more workable minimum level is probably $1.25-1.5Tn
So setting aside any reverse repo reverse sterilisation, essentially the Fed and Treasury could drain all functional excess reserves from the system by end the of September, certainly by year end with another 3 months of fiscal deficit and QT.
Now if they are selling that many Treasuries and dont want real rates to rise, other USD holding investors need to buy Treasuries.
And to buy Treasuries they need to sell something else.
Most probably they will sell the assets that have risen the most this year and which would be most exposed to a recession. Namely US equities and US HY and we see a leg higher in the USD.
As such we are more or less at a liquidity inflection point.
We have another month for real money to adjust their portfolios before going into the summer period and reduced market liquidity.