Hey guys, I just did a really fun video with @Aahan Menon on the current economic outlook and how to trade it. More importantly, we talked about trading the catalyst of the TGA emptying over a trillion dollars out of their account! You need to know this catalyst because it will be one of the major driving factors as we move through Q2.
The goal of this video is two-fold: Educationally explaining where we are in the economy cyclically and also how liquidity is currently functioning in this market regime. I have gleaned so much value from Aahan's research and conversations with him. Some of the best trades I have put on, stem from reading his research (https://prometheusresearch.substack.com/). I only plug him because the research is exceptional and free!
Several of the topics we discussed surround @Raoul Pal discussion about liquidity and if we are really in a bubble.
Enjoy!
Great macro summary. Esp at the end . Super clear explanation of the 3 levers: Growth, Inflation, Liquidity and the relative weighting of flows across these.
I am sorry but for me, you don't demonstrate a sufficient understanding of the basic mechanics of how the banking/monetary system works.
Your replies to comments in this thread about banks buying the long end / maybe driving the short end negative ... are just ... incomprehensible.
Aside from a trading desk at a bank (which will control much less $ limits and is hence inconsequential); if the Treasury desk has reserves that it is struggling to find an asset to invest in with a risk adjusted return above the IOER ... it will do nothing.
It could invest longer ... but then it would be taking IRRBB and would have to hold capital ... but ceteris paribus the previous example was constrained.
You can talk about "equities" (I turned off at 10 mins after hearing enough untruths) but keep to customers of banks.
If I go to .. https://prometheusresearch.substack.com/p/qe-impacts-and-implications
It is clearly preposterous to argue "Reserves created by the Fed remain stagnant in commercial banks as cash assets."
... who is the contra to some/all of these transactions? The assumption seems to be it is 100% bank transactions (just absurd).
"The difference this time is that the ON RRP rate is 0%, so should bills trade below the ON RRP rate again they will be negative. "
Why are bills trading below zero? Banks won't cause this since they can leave reserves earning ~ 0%. Who is doing this at zero maturity?
Hi Jeremiah S,
I really enjoyed the video and learned a lot. I appreciate the time and effort you both put into sharing this level of information. Also, Jeremiah S you did a great job transforming the information and helping me understand how it fits into the overall trading perspective.
Thanks,
-Kazu
Thank you for that feedback ! Glad it helped
Nice interview. Really helped me understand some of the mechanics better.
This was a lot of fun @Jeremiah S, always great exploring these complex subjects with you.
If I can sum up part of interview and this you note you wrote (https://prometheusresearch.substack.com/p/qe-impacts-and-implications), at least as far as I understand, the liquidity injections are sitting in bank reserves and not flowing into real economy.
Rather, banks keep it in cash or put in securities, resulting in asset price increase but not necessarily real economy impact (except to the extent increases in equities, home values, commodities, etc have real-world impact and make a section of population wealthier so long as everything goes up).
To me, this just sets up a huge disappointment down the road as liquidity driven asset price inflation faces the reality of the state of the economy, with the question about inflation still open and a potential equity downturn having real impact on wealth and economy.
I'm beginning to leaning towards inflation, but keeping in mind this RV interview with Jeffrey Snider that helped me understand the issue of bank reserves and deflation/inflation narrative.
https://www.realvision.com/shows/the-interview/videos/the-inflation-fairy-tale
Hi Aahan,
at 35:49, the 'Market Cap and Earning Mismatches Abound' table, would communication stocks pay a higher dividend vs. the other three: consumer discretionary, financials and industrials. Communication was the only one with positive earnings inside the rectangle.
at 1:06:05 - The peak in 2020 in the TGA and Bank Reserves - Is this related to currency in circulation / the amount of currency printed in 2020? You may have answered this in your presentation, but am trying to 'sum' this up in my head. Sorry about the money pun. Thanks again for the video.
-Kazu
Question: With regard TGA draw down and reduced Tbill issuance, will banks buy longer dated treasuries thereby pushing down all yields on the curve (since there are not enough Tbills to buy)? or do they instead buy riskier assets like RE securities, commodities, equities?
Am I thinking about this right?
So they would buy the long end of the curve before they bought other assets. However, this doesn’t necessarily mean they will buy the long end. They could just buy the short end and push it negative even tho that Wouldn’t Be the greatest outcome.
if the Fed is going to start buying equities and commodities then there would be to be a much bigger problem and they’d likely have some kind of interaction with congress before they did.
@Chase Winter that's a good assessment of the piece we most recently wrote on QE. However, more things are happening than just QE, so I would be careful to jump to conclusions on the real economy. Even if QE can't create activity, fiscal spending or simply the normalization of spending both in terms of distribution and magnitude could significantly bolster the economy. So the likelihood is, we're going to see an accelerating growth situation during the year- especially in the YoY numbers.
Regarding inflation, we do pretty deep dives into inflation data. We're currently not seeing inflation at the macro level, even though some pockets of the economy mar markets are pointing to higher inflation. We've written about this here:
https://prometheusresearch.substack.com/p/the-misbehavior-of-market-implied
If they cant get a hold of enough Tbills, what would be the reasons of not buying long dated bonds and jumping directly into risk equities? Is how I’m thinking.
@Billy T you're thinking about this right! Banks typically don't want to take on long-end risk, due to the increased volatility and liquidity risk further out the curve. There are similar risks in higher-yielding assets- banks really prefer liquid shorter-duration investment assets. The problem isn't that they can't get their hands on Treasuries per se, it's that too many people are trying to do the same thing. So if you look at the Treasury bills market last year, you'll see interest rate actually went negative at the peak of the Feds QE. This is because everyone wanted the safety of bills, even if they had to pay for it. At this point, the Fed realized what they were doing and transitioned to buying more Treasury notes instead. Likely, we're going to see something similar in the notes market (not to the same extent) and the Fed will want to increase the maturity of its portfolio.
@Kazu Williams thanks for your questions. I don't think the distribution of earnings is really relevant to this dynamic. Whether companies choose to distribute earnings or not is really a matter of discretion. Further, most returns today will be made on actual price increases of your stock. Through this lens, earnings are really just a way to see how much your market cap is "justified." As you rightly pointed out, it seems more justified in some places than others.
Regarding TGA, reserves, and currency in circulation: These are all separate items. As the banker to the government, the Fed has the following liabilities (the Fed owes everyone this promissory notes):
Treasury General Account (Govt Cash)
Currency in Circulation (literal cash)
Bank Reserves (Bank cash kept at the Fed)
Currency in circulation isn't the item that increased; the other two did.
Regulations won't allow you to have that kind of risk on your books in size.
@Aahan Menon Interesting. Gosh the probabilies are tough to pin down. Not sure how to allocate, lol!
Then don't force it. All the Prometheus data is pointing to a reflationary environment in the US. Pick and choose your trades & have a balanced portfolio strategy.
Am thinking what a net 1 Tn of TGA drain could look like from a banking system perspective?
Thinking of levers like: