Reading the markets

By: Michael W Arone, CFA, Chief Investment Strategist

This business requires all of us to read a lot. Like you, I appreciate the rigor of solid research, the suspense of a good plot unfolding, and the beauty of a perfect sentence. In this series called Reading the Markets, I’m excited to share my thoughts on some of the interesting ideas I discover.

It’s been a little more than a year since the Federal Reserve (Fed) responded to the regional bank challenges by launching the Bank Term Funding Program (BTFP), which unwound five months of quantitative tightening by injecting more than $303 billion dollars of liquidity into the market.

That kicked off a liquidity infusion that supported a 19% surge in the S&P 500® through July, from its 0.6% year-to-date gain when Silicon Valley Bank failed in March.1

Liquidity Headwind in April

While investors tend to under appreciate the positive impact liquidity has on markets, they do notice when liquidity recedes. And, as Strategas Research Partners warns in “Liquidity & Fiscal Squeeze Has Arrived,” three critical components of liquidity — the Fed balance sheet, Treasury General Account, and reverse repos (RRP) — could turn negative in April and cause a temporary liquidity squeeze.

Figure 1: Decline in Overnight Reverse Repurchase Use

What’s driving the liquidity drain? According to Strategas:

  • Taxpayers are expected to withdraw upwards of $250 billion from the financial system to pay their taxes.
  • The Fed abruptly ending the BTFP in March means banks have already begun to repay their $160 billion in loans due over the next year.
  • The Treasury is expected to retire $300 billion of T-bills in the second quarter, the first reduction in more than two years. And less T-bill issuance means higher RRP balances.2

Reacting to Volatility

We’re already seeing some volatility, but I don’t believe investors should worry. When liquidity contracted in August and November last year, the Fed and the Treasury came to the rescue. That will likely happen this time too, especially since it’s an election year.

The Fed continues to signal rate cuts and may slow its Quantitative Tightening later this year. And after tax-season, the Treasury will have more than $1 trillion available to spend heading into November’s election.

So, while the threat of a liquidity hiccup in April is real, I don’t believe there’s a need to reposition portfolios because it should be short-lived. But the brief window of volatility could feature attractive pricing that may prompt some investors to move hefty cash balances off the sidelines.

A temporary liquidity squeeze doesn’t change our positive outlook on equities. From the expanding economy and strong labor market to growing earnings and high profit margins, the backdrop remains very attractive for risk assets.



Originally Posted April 3rd 2024, on State Street Global Advisors’ blog


1 Bloomberg Finance, LP., as of March 26, 2024.
2 Policy Outlook, Strategas, March 25, 2024.


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