As liquidity dries up, banks are becoming less interested in lending to each other.

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The Interbank Debt Market: A Warning Sign For The Stock Market’s Future

The cash that is currently flowing into the reverse repo market will flow into some of those Treasurys, but the problem is that market is an overnight program. Treasurys are longer denominated instruments. Liquidity is going to flow out of the system at a rate we have not seen for a long, long time, if ever.

When this happened before, we didn’t have the inflationary pressure created by massive government overreach and spending during COVID and post-COVID with the first Biden budget that we have today. Coming into an election cycle, it will be impossible for the government legislative bodies to solve for the lack of liquidity. The Fed will be in a very tough spot to try and solve it since it is the inflation fighter now. Creating more liquidity will spur higher rates of inflation.

Not only that, but the Fed has to be worried about unemployment. Data show that in places like Costco, customers are buying more chicken and pork than they are beef. Is that a change in consumer preferences or is it a sign of recession? States like California have seen tax revenues plummet. Is that a sign of recession, or that startups have laid off people and people have fled the state? All this creates more risk in the stock market, but currently we are witnessing a relief rally after the manufactured debt-ceiling drama. Right now, the VIX, a measure of risk in the stock marke,t is collapsing to year lows.

It is anyone’s guess to where you might see the crack forming. Some people think we will see it in the listed options market.  If there is a larger than normal activity of put buying, we ought to see it in prices. Others speculate that a collapse in the cryptocurrency market will be the first sign, because cryptocurrency is a highly risky and fickle asset class. Another place to watch is the secured overnight financing rate (SOFR) contract at the CME Group. If the near-term SOFR contract starts to aggressively get bid up in value and seems disjointed with the rest of the debt market, it’s a sign that banks don’t want to lend to each other and that there is a lot of fear in the market.

Banks Say New Capital Requirements Will Stifle Lending 

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