“You will return to the scene of the crime when the river runs dry”, Hunters and Collectors
Those of a certain age, and geographical bias, will remember Hunter and Collectors back in 1989 singing about the dangers of a disappearing liquidity in When River Runs Dry. Not sure what it meant, but it was vaguely threatening. You can see the video here.
Inspired by similar vaguely threatening developments, we’ve built a useful measure of US financial system liquidity demand. It compares actual Fed reserve balance provision against a modelled liquidity function and theoretical boundary of reserve demand from the banking system. Bottom line; the system is already close to a theoretical boundary of liquidity and the steady reduction in the Treasury General Account (TGA) may reduce the buffer of reserve availability further. The likely fraught discussions over the Debt Ceiling in Congress suggest the TGA depletion may introduce some money-market stress, with important implications for Treasury markets, and maybe the wider financial universe. In response, the Fed may begin to conduct ad hoc repo operations, possibly at the same time as QT continues (albeit at a lower rate). Most observers may miss this but it would be an important signal of the limits of Fed balance sheet reduction. More detail is elaborated for paid subscribers below, including the model parameters and results.