Summary Market liquidity is tightening as Fed reserve balances have declined by $500 billion since July, draining support for risk assets. Overnight funding markets remain tight, with increased pressure around Treasury settlement dates and limited relief expected from TGA adjustments. Bitcoin and equities are both feeling the liquidity squeeze, with Bitcoin down over 20% and the S&P 500 appearing expensive relative to reserves. Future Fed balance sheet expansion may eventually ease pressure, but easy monetary policy is unlikely to return soon. The liquidity drain we are witnessing in the market appears very real, well telegraphed for months, and is now being felt by risk assets. The liquidity that has left the marketplace is unlikely to return. Reserve Balances held at the Fed have fallen to $2.88 trillion from $3.38 trillion in the middle of July following the resolution of the debt ceiling. That means that over that period, about $500 billion was drawn from reserves as the Treasury General Account was replenished. Macrobond TGA Drain As the TGA rose, it drained excess cash from the reverse repo facility, effectively making it largely unused. As a result, overnight funding rates rose, and the usage of the standing repo facility rose. Signs that liquidity in the overnight funding market was tightening. Macrobond At present, the TGA stands at $943 billion, which is more than the $850 billion the Treasury Department has targeted for the December and March quarters, according to the latest quarterly refunding announcement . Macrobond That means we are likely to see the TGA fall by around $90 billion between now and year-end, which could help boost reserves back to around $2.9 to $2.95 trillion, but in the end, it probably won't be enough to materially change the tighter liquidity positions in the overnight funding market. The Treasury still has a lot of debt to issue, and there are settlement dates on the calendar when we tend to see overnight funding rates rise, tightening liquidity and widening spreads. More recently, we have seen the standing repo facility used more on treasury settlement dates. When usage at this facility increases, it means overnight funding rates are trading above 4%, the rate at which an institution can borrow from the Fed. Macrobond Importantly, until the Fed actively increases the size of the balance sheet, reserves will likely remain around their current level, just below $3 trillion. That is going to keep the overnight funding market tight, with increased pressure on Treasury settlement dates, tax pay dates, and quarter and month-end. Risk Assets Feel The Pain In the end, risk assets appear to be feeling the effects of the liquidity. Bitcoin USD (BTC-USD) has been the standout, with the cryptocurrency now having fallen by more than 20% since the middle of October. The movements of Bitcoin and reserves appear very similar, but it is the timing of those movements that makes it an imperfect comparison. But it seems clear that when reserves are abundant and liquidity is ample, Bitcoin can thrive; when reserves are shallow and liquidity is tight, Bitcoin pays the price. TradingView Over time, equities have followed the same footsteps as reserves, but again, not in a way that is easy to measure. One measurement worth tracking is the market cap of the S&P 500 (SP500) relative to reserve balances, and the ratio has expanded quite a bit, reaching 19.9. That is easily the most expensive the S&P 500 has been in terms of reserve balances. There may no longer be enough liquidity in the marketplace to support stock prices at their current levels. Macrobond At some point, the Fed will be forced to expand its balance sheet again, and this pressure will ease, but that doesn't mean it will be a party for risk assets. The latest round of easy monetary policy, which started in 2020, was extraordinary, and it has literally taken years to work its way through the system. That is over now, and the Fed is likely to be much more careful in the future when it comes to balance sheet expansion and its potential economic impacts.
