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Significant Liquidity Withdrawal Coming in June
The tide is about to go out in a big way. Let's see who's swimming naked.
The Fed’s Reverse Repo Program (RRP) typically rises in the last two weeks of the quarter on banks window dressing and risk reduction. Over the last 8 quarters, the average growth in RRP has been $304bn (range $151bn-$472bn). On its own, this is a significant liquidity drain that often leads to risk asset pressure toward the end of the quarter.
This time around however we will also be seeing the Treasury look to refill the TGA after being drawn down aggressively from the beginning of the year, now that the debt ceiling issue has been resolved. Yellen has said in the TBAC report that cash levels at end of 2Q can be $550bn and up to $600bn to end 3Q. Given only 1 month to go, that's a bit unlikely but with aggressive T-bill issuance in the coming weeks, it seems plausible that she could net raise $250-300bn into the TGA, representing another significant liquidity drain in the coming weeks.
With the yield on the RRP at 5.05% (and possibly rising to 5.3% if the Fed raises next week), Treasury will have offer incredibly attractive yields in order to incent the money from the RRP to buy these accelerating T-bill auction supplies which suggests continuation of higher yields in the front end of the curve, draining liquidity and providing a further headwind to risk asset valuations. If the money doesn't come out of the RRP, it will have to come out of bank reserves, the main driver of financial system plumbing.
We are also going to see the standard $95bn of QT for the month of June which is very much back end weighted. More liquidity coming out of the system as reserves are drained.
Markets are entering the month of June with a fair bit of euphoria for growth stocks but are facing a historically, extraordinary amount of potential liquidity drain in a very short period of time in the coming weeks. The correlation of liquidity additions/subtraction with risk asset performance is very well documented to be rather high. This is not a time to be a hero. When the tide swims out, we see who swims naked. Time to hedge up and risk down to navigate the coming liquidity shitstorm.
Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.