RRP + TGA

OK, let’s get into it. Sometimes someone says something that jars our memory and reminds us to check some charts. Our buddy Paulo Macro has done just that and as a result, we’re going to shamelessly steal from his recent piece. Please subscribe to see his other writings.

We’re of the view that the global economy is sorta meh. Maybe even bordering on worse than meh, with the trend to the downside. You can choose your favorite indicators, but most of them point to meh, unless you’re touching AI/datacenters/semiconductors, or you’re touching the wealth effect from equities. Now, we’ve been pretty public in our view that AI will eventually change our lives, yet be a flop from an economic return standpoint. Now, let’s talk a bit about the wealth effect from the US equity bubble. What if it’s all simply driven by liquidity??

Let’s talk about QE. You all think it’s done. You may even think we’re doing QT today.

You see, they did too much QE when they were using the printing press to fight germs (remember how fun that was??). Then, they flipped to QT, but that excess QE got stored up in the Reverse Repo (RRP).

You can see the bulge of deferred QE and how it’s deflated starting in 2023. Despite the Fed doing QT, the net liquidity from the RRP has been more than offsetting the QT, hence why equities keep levitating.

The Treasury also has the Treasury General Account (TGA). Think of this as their checking account. They issue bonds to fill it up, then spend it on stupid sh*t to drain it. We know that equities are highly correlated with the changes in the TGA balances. Smart Treasury secretaries have even used it to create mini equity-market booms before elections, especially as stocks increasingly trade on liquidity injections, as opposed to economic fundamentals.

When liquidity comes gushing, stocks roar. When liquidity slows, or goes in reverse, stocks smash.

I’ll let Paulo take the wheel at this point…

You can clearly see the drawdowns toward zero in late 2021 and mid 2023 when Congress fought over the debt ceilings. In the 1H22 rebuild (more bonds issued than proceeds spent), the liquidity suck was real, as equities peaked to the moment in December 2021. But in 2H23 the market havoc didn’t happen. What people missed at the time was that Janet Yellen was able to pull a rabbit out of the liquidity hat known as the RRP (reverse repo facility), by tilting Treasury issuance away from coupon bonds into T-bills without impacting equities. In fact her issuance had the opposite effect — it goosed risk assets higher via stimulative interest payments on cash to the “top 10%” savings class, without the typical liquidity withdrawal a TGA rebuild entails.

Basically, the RRP offset the TGA rebuild in 2023. Now, with the debt ceiling, we’re drawing on the TGA again (hence stocks levitating). The difference is that our RRP buffer is running thin. When we finally pass Trump’s BBB, they’ll have to refill the TGA and do it at a time when there isn’t enough room left in the RRP. That’s when we should be looking for a smash. Probably timed about right when the vol control funds are re-grossed, and when Q3 guidance gets reset by corporates announcing their Q2 results, which is sometime in late July/early August. That’s when we’re on alert for fundamentals to take hold again. Until then, who knows what happens to equities. They seem to be blowing off on endless liquidity. Maybe we’ve been too bearish in this regard. But we stand by our view that the macro data is rolling over. Besides, it isn’t even really a market. It’s a handful of tech names with an endless bid. Look at the chart below. This rally is not broad at all.

…and while we’re always skeptical of these historical seasonality charts, they do have a funny way of repeating, and the timing also says that it’s lining up with the TGA refill.

In summary, we’re bored out of our minds. We’re sitting on cash and doing very little. There just aren’t many exciting trends to latch onto. We are still bearish. We genuinely expect a smash, which comes from the bond market. From there, we think that they panic and let liquidity flood the system. They do YCC and TWIST, they QE it, they tell stocks to blast off…but first they give us the TGA smash.

What if… and it’s a bit if… what if the rest of the decade has negative real GDP growth, and it’s all simply a giant asset bubble that rolls around. We all ‘feel’ rich, but we’re getting poor. Stocks go up, but eco data doesn’t. What if it’s a brave new world afterall…??

Switching gears a bit. We’d be remiss if we didn’t note the Russell Rebalance. It’s Christmas for value investors. Kick through the lists and see if anything deleted looks interesting. We expect a few gems to emerge…

Barclays Cheat Sheet