Liquidity thesis drives stock market and bitcoin rally

The liquidity 'kraken' driving stock markets and bitcoin into 2024

Stock markets and bitcoin are rising not because of profits, but because someone is refilling the money system. This is the thesis held by a current of analysis since early 2023: the Federal Reserve’s monetary policy and the US Treasury’s fiscal policy will inject liquidity in a volume capable of dragging risk assets well into 2024, with US elections on the horizon. The starting point is October 2022, the British episode dubbed Liz Truss Gate in this analysis.

What is debt repurchase and why was it called a twist operation

The mechanism has a technical part that explains almost everything. The Treasury issues bonds at various maturities each year, and the most recent issuance of a specific term—the on-the-run—is the one the market accepts as collateral in credit and derivative operations. The previous ones, the off-the-run, lose liquidity even though they still generate interest. When British pension funds needed to sell those old bonds to cover payments, they found no buyers. The Bank of England intervened by exchanging them for free for newly issued bonds equivalent in maturity and liquidity. The market stabilized and the stock market began to rise.

The reading extracted is that the US Treasury would replicate that scheme. At the end of 2022, Janet Yellen hinted she would do something similar, and in April 2023 she confirmed that repurchases would come in 2024, according to the information gathered then. The initial name of twist operation generated confusion, because a classic twist buys long bonds and sells short ones, whereas here it is a debt renewal without altering the maturity profile.

October 2022: The day global liquidity hit bottom

The floor of global liquidity is dated in October 2022. The Bank of England intervention marked the turning point and the continuation of the bear market that many expected for January 2023 never arrived. Since then, each correction has been absorbed. Bitcoin rose by 13% in three sessions in one of those starts, and indices chained highs that bears failed to read. The repeated conclusion is uncomfortable: what came after was not a bounce from lows, it was something else.

Why do RRP and TGA decide how much liquidity circulates?

Available liquidity is calculated with a simple subtraction: Fed balance minus RRP minus TGA. The RRP is the money funds park in the central bank overnight; the TGA, the Treasury’s current account at the Fed. The higher the latter two, the less money circulates through the system. The data being handled were uncomfortable: the RRP rose from 2.194.631 to 2.279.608 billion between March 21 and 22, 2023, and reached 2.321.699 billion on April 13. Hundreds of billions parked just when liquidity was needed.

In parallel, the Treasury’s account was bleeding: 78 billion dollars in a single day, a quarter of the US Government’s money. One interpretation that circulated was that it had covered the deposit guarantee fund. And at the other end, money funds accumulated 5.43 trillion dollars on June 30, 2023, a record read here as dry powder waiting for a destination.

The debt ceiling and the bullish trap of summer

The summer of 2023 introduced an uncomfortable nuance to the thesis. Resolving the debt ceiling forced the Treasury to refill the TGA with hundreds of billions, and that money leaves the system except for the part that might draw from the RRP. The calculated effect was bearish: less liquidity, more paper to place, and markets exposed to any volume of sales. Hence the hypothesis of a bullish trap: initial rise after the agreement, insider sales, and fall until September.

The most benevolent scenario maintained that the drain would be limited because the issuances would be very short-term and absorbable by money funds. Weeks later, the composition changed towards longer maturities and the argument became more fragile. With it, calm.

The Chinese boost and money parked in money funds

The external boost came from China. The Chinese central bank injected 666 billion yuan in two days, after 602 billion the previous week, a figure described as the kraken released. Chinese liquidity conditions commodities and global flows, although its effect on manufacturing points in the opposite direction: input prices up, finished products down.

Added to this was a concept that began to circulate strongly, that of fiscal dominance. If real rates returned to their historical average of 2%, with the level of US public debt and projected deficits, the country would immediately enter a sustainability problem, according to the calculation attributed to Charles Calomiris. Governments have incentives to liquidate debt via inflation. The Federal Reserve’s own loss account, which pays more for its liabilities than its assets generate, functions in practice as an injection through the back door.

Liquidity yes, but not in a straight line

In August, Michael Howell, a reference author on global liquidity, described the end of the quantitative easing cycle started in 2008 and the entry into a different scenario: an upward trend until 2026, with inevitable pullbacks. The warning fits with the rest of the diagnosis. The direction is one; the path is not a straight line.

There remains a loose end that no one closes. The emergency loans granted to banks have maturities of one year or three months depending on the program, and most have been placed for less than fifteen days, so that the bulk of the high-rate effect has not yet reached companies. When it does, the question will be what holds up first: credit or public debt. Meanwhile, the dominant bet remains the same. Buy risk and wait for 2024. With reservations.