Liquidity’s Tightening. Watch Out!

Posted July 12, 2023

One of the main themes of Macro Watch is that Liquidity Determines The Direction Of Asset Prices.

This week Macro Watch shows that Liquidity is contracting again and explains why Tightening Liquidity is likely to put downward pressure on Asset Prices during the months ahead, potentially making the second half of 2023 a challenging time for investors.

Three factors are causing Liquidity to tighten:

1. The Fed is destroying Money through Quantitative Tightening (approximately $95 billion a month),
2. The US Treasury Department is replenishing the Money it holds idle in its Treasury General Account (TGA), its “bank account” at the Fed, and
3. Because some of the Loans the Fed extended during the Silicon Valley Bank Crisis in March are beginning to be repaid.

The video illustrates how these developments are impacting the Fed’s major assets and liabilities; and, in the process, explains how the Fed creates and destroys Money.

The Fed is unable to carry out Monetary Policy as it did in the past.  The creation of trillions of dollars through Quantitative Easing since 2008 rendered its old tools for controlling interest rates and regulating credit creation obsolete.

Consequently, the Fed was forced to devise a new process to control the Federal Funds Rate by paying interest on Bank Reserves and Reverse Repurchase Agreements.  This video explains everything necessary to understand how this new process works.  In fact, it is a mini course on how the Fed carries out Monetary Policy today.

Viewers will learn that while the Fed’s new policy approach is effective, it is also very expensive.  The video shows that as a result of its new policy for controlling interest rates the Fed is now losing extraordinarily large amounts of money.  

Since September last year, when the Fed first began losing money, it has racked up accumulated losses of $76 billion.  Worse still, the Fed is going to lose a great deal more than that before this interest rate tightening cycle is over.  This is a harsh reversal of fortune given that in 2021, if the Fed had been a corporation, it would have been the most profitable corporation in the world.

The video concludes by showing that Total Liquidity, which is already $850 billion below its peak at the end of 2021, is on course to contract by a further $1 trillion before the end of the year.  If it does, something is likely to go very badly wrong.  The banking sector crisis that began with the failure of SVB could resume, the stock market could experience a brutal selloff, or some other part of the financial sector could seize up. 

When such a shock occurs, the Fed will be forced to end Quantitative Tightening abruptly, as it did during the crisis in the Repo Market in September 2019.  Until then, however, look for Liquidity to become increasingly tight.

Contracting Liquidity should put upward pressure on interest rates and downward pressure on asset prices because there will be less money left in financial markets to be invested in bonds, stocks, property, and the other asset classes.

For all the details, Macro Watch subscribers can log in and watch this video now. It is 25minutes long and contains 48 slides that can be downloaded.

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