“Wknd thought: Very Long Thread on System Liquidity
Some see a raging bull market. I see a system exhausting every last bit of available liquidity for one final dance.
Those who argue bullishness on solvency (pointing to high aggregate household wealth or strong asset-to-margin-debt coverage) miss the point. Credit Suisse had a CET1 ratio of 15% (better than most peers) right before it was seized.
When asset and capital appreciation come from ample liquidity rather than fundamentals, arguing bullishness on high asset coverage is as circular as it gets.
Everyone agrees we got here thanks to liquidity. Bear Stearns, Lehman, SVB, and CS all met their demise when their access to daily repo mkt got cut off. That is why repo matters.
And repo is running out.
But here is what many do not grasp:
A rate cut by itself does not directly increase bank reserves, the foundation of all liquidity. That requires an active reserve addition by the Fed or a TGA drawdown.
What a cut does instead: capital moves from lower-yielding low-risk to higher-risk assets in search of returns. In other words, money just changes hands without increasing total system liquidity. So do not confuse this when people say “low rates = more liquidity.”
And this MMF being money sitting on the sideline as additional liquidity buffer is one of the greatest misconceptions in markets. Instead, it is already being lent out as precious collateral in the repo market, which is getting tight.
Once a rate cut occurs, and if we see a meaningful reduction in MMFs (i.e., a cut without active reserve addition), that means repo supply and collateral disappear. Imagine what that does to margin debt and system leverage.
Yes, the money flowing out of MMFs will in theory eventually find its way into risk assets. But sequencing matters.
So the system will soon need more than 25–50 bps of cuts.
Without exaggeration, we are nearing the precipice. We will need active liquidity injections. (Something the current gold rally looks to be predicting?)
And the question is whether TPTB effectuates that liquidity injection/big transition (be it QE or currency reset) before we face pain (and if so, how much).
(Side note: yes, we have the SRF to bridge the liquidity gap. But its usage implies SOFR ≥ FFR + 17 bps / IORB + 10 bps. When so many repo trades live and die by basis-point moves (like basis trades), you are already in a bad place if the SRF is being tapped.)”