Right now, money has got tight. The Fed has been bringing down its balance sheet for ages to try at least to make it look less titanic and meanwhile drain all the excess cash in the system that has driven and underpinned inflation since Covid.
Here is the picture of that primary strategic tightening, generally called QT. QT stands for Quantative tightening and is the opposite of QE. QT means tightening/decreasing, the Quantity of money, in the financial system.
Here is that chart.
Depending on how you gauge past inflation, the Fed balance sheet might be back near pre-covid levels, but that is not the point.
The point is, QE = ‘market up’ so QT should mean the market down. However, QE beyond a certain point generates too much money in the system which would create huge inflation but the Fed sucks it up in another banking system, called the ‘Reverse Repo,’ where it pays banks to stash their extra cash back with them rather than lend it out to sketchy borrowers who might never pay it back and who would spend it in an inflationary way.
Here is the chart of the reverse repo. That mountain of cash is the excess ‘liquidity’ ie Cash, caused by the Fed trying to avoid an economic meltdown during covid lockdown by printing vast sums of money to inject into the system.
The bottom line now is all the spare cash that was in the system is now gone. Now that’s not a problem unless not only is all the spare money is drained from the system, but in fact even more has been drained and the process has gone negative. In other words, if you drain all the spare money from the system, then you drain more, you end up with not enough money in the system and markets start to get desperate for cash. This is the financial plumbing game that the Fed has to constantly play.
So to cope with this potential outcome, yet another facility is in place called the SRF, ‘the standing repo facility’ which is a barrel of cash major banks can call on if money gets tight because of unexpected events. It was a big deal back last year when Silicon Valley, etc went bust and nearly created a domino effect of a US wide bank run. It was the SRF facility that stopped a bank run for kicking off in earnest by providing an instantly accessible mechanism for banks and financial institutions to grab cash to avoid the system ceasing up.
That process has been in play again and this chart, while not the SRF is an indicator of emergency funds being injected into the financial system right now. Its pretty surprisingnot to say scary!
In my way of looking at it, this is what is shaking the market about right now and stopping the market in its tracks. Move flow is what drives prices and when the river of money dries up so do bullish price moves.
Basically we are in a financial crisis and its being handled in such a way all we are seeing is a wobble in asset prices. In the old days when this level of regulation was simply not a thing, the market would have tanked, but as you can see its being propped up with cash and instead of a crash we get a jitter. That quite a nervy situation to be in.
So the call is, will the Fed keep the wheels on, or will the wheels come off this time?
If they come off there will be a meltdown. If they don’t, normal service will resume in a few days perhaps a week or two.
Normal service is what I’m expecting but right now you can see the ripple on the surface of the market caused by the subterranean earthquakes of government shutdown and disrupted money supply and that is enough to be very wary.
It is not all down to the US government shutdown, this is caused by its intersection with the empting of the reverse repo and the tail end of QT. The reopening looks to be proving to be disruptive which is hardly surprising, but it should be temporary.
That disruption will resolve in the coming days and the old new normal will resume.