Liquidity Squeeze?, What Liquidity Squeeze?

Once the (insane) debt-ceiling hostage-taking was resolved, most analysts with a microphone or a keyboarded were predicting and warning that there would be a catastrophic liquidity squeeze and market crash as the Treasury created debt-securities to refill the TGA (Treasury cash account) and to pay back the government Agencies – that were raided during the ‘extraordinary measures’ period. In this piece, we explain why we were predicting a bull rally instead of a liquidity shortage, weeks before the debt-ceiling was raised.

In May, before the debt-ceiling was raised, we stated (here) that raising the debt-ceiling would lead to new highs in the stock market if there were no significant spending cuts. Two months later, government spending continues at pace and the SPX is rallying close to new all-time-highs.

The reason why we counseled our investment group to continue going long has to do with the fund-flows from the Treasury into the economy (private bank accounts), and the funds that were available in the ONRRP (overnight reverse repurchase) facility.

So far this fiscal year, +$1,260B has been net-transferred from the Treasury into private bank accounts (the US economy) which, following the raising of the deb-ceiling, was matched with the sale of Treasury-securities – which means reserves were deposited into Treasury-security savings accounts at the Fed. This did not cause a shortage of liquidity, as was broadly-feared, because the Fed provides the primary-dealer banks with the reserves they need to purchase the T-securities – which, by regulation, they must purchase.

Historically, the rise in the stock of Treasuries correlates positively with the SPX. Right on cue, and as we expected, the market has rallied hard along with the increase in Treasury-securities (green horizontals on chart below).

In addition, the TGA (Treasury General Account), which had been drained while the debt-limit was in effect, had to be “refilled”. The mainstream media insisted this would cause a severe drain of liquidity and lead to a market pullback. We, however, have maintained all along that the liquidity-drain would be insignificant because there was ~$2.5T sitting in the ONRRP (overnight reverse repo) facility. The chart below shows how the TGA was recharged from the ONRRP; $500B was redirected from ONRRP to the new Treasuries that were sold, thus not removing free liquidity like the majority feared (chart below).

Our own proprietary liquidity model shows there was only a modest reduction from pre-debt-ceiling-raise levels (chart below).

The stock market is fueled by fund-flows and, as we have demonstrated above, there is no liquidity shortage. The Treasury is on-pace to net-transfer $1,600B into private bank accounts in fiscal 2023 (which ends in September), and since fiscal 2024 is a presidential election year, the deficit-spending is unlikely to be reduced: only 4 of the 24 presidential elections since 1928 were down-years for the stock market. Investors should stay long stocks via broad spectrum ETFs such as QQQ, DIA, and IWN.

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