ACTV - The S&P 500 May Be Heading Back To October Low Very Soon

2023-04-14 12:46:25 ET

Summary

• Liquidity is likely to make a big u-turn over the next couple of weeks.
• Reserve balances at the Federal Reserve have risen in recent weeks, but that's due to reverse.
• The Treasury General Account is down to its last $85 billion and is set to rise significantly as tax season comes to an end.

The recent wave of liquidity in the equity market is near its end. Depending on how much the reserve balances sink over the next two to three weeks could result in the S&P 500 even falling back to its October lows.

Much of this will have to do with the Fed balance sheet, which shrank this week as the banking "crisis" begins to ease and activity at the Fed's lending facilities diminishes. This has led to reverse balances dropping due to increased usage of the reverse repo facility as investors have pushed money into higher-yielding money market accounts.

This has sent the reserve balance lower recently, but those reserves could be set to drop even further, especially now that the Treasury General Account has just $85 billion on hand. The decline in the Treasury General Account has helped to provide the markets with excess liquidity. But with tax receipts set to pour in and the recent debt issuances, the Treasury General Account should rise, which should work to drain liquidity from the markets.

The Treasury General Account has fallen sharply in recent weeks, as the Treasury has used extraordinary measures due to the current debt ceiling debate. The TGA hasn't fallen to levels this low since December 2021.

The annual tax filing due date comes next week, and the inflows from tax season will need to be high to give the Treasury the cash required to run the government while Congress works out the details on the debt limit.

This increase in the TGA from taxes will affect markets as it will work to reduce overall reserve balances held at the Fed, which work to drain liquidity and push the S&P 500 lower. The chart below shows the S&P 500 and the TGA (inverted) relationship. A falling TGA helps free up reserve balance, thus adding liquidity to the market, and a rising TGA removes reserve balances, thus draining liquidity from the market.

In the two weeks from April 13 to April 26 last year, the TGA increased from approximately $540 billion to $975 billion, an increase of $435 billion. This sent reserve balances from $3.8 trillion down to $3.3 trillion. This also resulted in one of the steepest declines in the S&P 500 in 2022.

Currently, reserve balances are around $3.3 trillion. An increase in the TGA over the next two weeks of a similar size as in 2022 would result in reserve balances falling to about $2.9 trillion and drain significant liquidity from the markets.

Additionally, the latest data shows that money market funds continued to rise and reached almost $5.3 trillion as of April 13. The increase in money market accounts appears to be funneling into the Fed's reverse repo facility, which has reached $2.3 trillion and is almost back to its highest levels in 2023.

But more importantly, the usage of the Fed's banking crisis facility has been declining, along with the repurchase agreements of foreign officials. As this decline or normalize due to the banking "crisis" subsides, it will further work to reduce the Fed's balance sheet's size.

In all, we could see a significant decline in the size of the reserve balances over the next two to four weeks, which based on my models that factor in the current loans made by the Fed and without the loans, suggest an increase in the TGA of equal size to last year could send reserve balance to as low as $2.6 to $2.9 trillion. But unlike the significant decline witnessed at the end of 2022, this decline would be longer lasting and could have a more profound effect on markets.

Again, historically, the S&P 500 has lagged changes in reserves balances by around two weeks, and if reserved balances begin to drop, the S&P 500 could very well be on its way lower, and depending on how far those reserves fall, it could be a pretty significant drop to come. Historically when the reserve balance makes new highs, stocks make new highs. When the reserve balances make new lows, stocks make new lows. A drop to the lows in reserve balance does leave the door open to a new low in the S&P 500, as far-fetched as that may sound, based on the historical trends.

So it's certainly worth being aware of the significant risk here if the TGA rises and reserves fall. The TGA is straightforward to track and is updated daily on the Treasuries website.

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