QQQ - The Massive Stock Market Liquidity Drain Has Only Just Begun

2023-06-07 12:00:24 ET

Summary

• The Treasury General Account refill is now underway.
• The Treasury estimates the TGA rising to $450 billion by the end of June.
• That could push reserve balances well below $3 trillion.

The debt ceiling has been resolved, and Treasury issuance has started again. The Treasury General Account ("TGA") is rising now. The Treasury noted today that it sees the TGA rising to around $425 billion by the end of June, up from $71.2 billion on June 5.

The increase in the TGA comes heading into the quarter end when there tends to be a surge in the Fed's Reverse Repurchase Facility usage. Depending on where the refill for the TGA comes from and how much money piles into the reverse repo facility at the Fed, reserve balances held at the Fed are likely to drop below $3 trillion and potentially below $2.8 trillion

The TGA Refill

The TGA and reverse repo facility are liabilities on the Fed balance sheet, so when they rise, they reduce the banking system's reserves. If the TGA refill comes directly from the reverse repo facility, which is made up mostly of money market accounts, then the net effect on reserve balances could be minor. However, if the TGA refill comes from a source other than the reverse repo facility, then the drain on reserves could be quite large.

While it is too soon to tell completely, early signs are that this refill is coming from other sources. The TGA has increased by $47.85 billion from June 2 through June 5, while the reverse repo facility has fallen by just $10.6 billion, which would be a net drawdown on reserves.

The Yield Curve Favors the Repo Facility

Investors may not have much incentive to move their money from the repo facility since the prevailing rate on the reverse repo is currently 5.05% , while the current rate on a 1-month Treasury bill is 5.02%, and a 6-month T-bill is around 5.4%. But the reverse repo rate also increases as the Fed pushes rates higher, so putting money in a 6-month bill at 5.4% may not be as attractive as it seems, should the Fed continue to push rates higher. It also means that most of the Treasury yield curve trades below the current overnight repo rates. If the Fed is true to its word that it plans to hold rates higher for longer, there may be little to no incentive for investors to move money from money market accounts at this point in time, especially as bets rise on another rate hike between now and July.

If the money to refill the TGA does not come from the reverse repo facility, as the TGA rises to the projected $450 billion, reserve balances could drop to below $2.8 trillion, which would be a big drain on the reserve balances from the current $3.2 trillion as of May 31.

Again, assuming the reverse repo facility doesn't experience an outflow, it could increase in the coming days as we approach the end of the quarter. Typically, around the 15th of the month leading into the quarter-end, the repo facility has surged anywhere from $150 billion to $430 billion. Pushing reserve balances even below $2.8 trillion wouldn't take much.

Consistent Valuations

The S&P 500 Index (SP500) and the NASDAQ 100-Index (NDX) have traded at fairly consistent multiples compared to reserve balances for a couple of years now, and currently, both of their valuations are at the very upper end of the range.

Since the summer of 2020, the NASDAQ 100 has traded on average around 4.55 times the size of reserve balances, peaking as high as 5.2 times at the upper end of the range and as low as 4.0 times at the lower end of the range. Currently, the NASDAQ 100 trades at 5.3 times the size of reserve balances. At five times the reserve balance of $2.8 trillion, the NASDAQ would be valued around $14 trillion, down from its current value of about $17.4 trillion, a drop of 19.4% in market cap.

Meanwhile, since the summer of 2020, the S&P 500 has traded between 9 and 11.6 times the reserve balance, and it's currently trading around 11.3 times. A decrease in reserves to around $2.8 trillion, evaluated at 11.6 times the reserves, would value the S&P 500 at $32.5 trillion, down from its current value of $37.3 trillion, a drop of about 13%

Historically speaking, equity markets have been tied to changes in reserve balances. If we should begin to see reserve balances declining and liquidity exiting markets, it is likely to result in falling equity prices.

How far equity markets can fall again will depend on where the money to refill the TGA comes from and how much the reverse repo facility increases heading into quarter-end. The liquidity drain could be painful if the TGA is refilled from sources outside the reverse repo money market account.

This is all very easy to stuff to monitor on a daily basis, and worth the 5 minutes of times to check how the refill is proceeding.

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