Original title: forget the Federal Reserve and Jackson Hole: the US Treasury's $500 billion quantitative tightening policy has a greater impact on market liquidity

Source: FX168

According to a recent article on the financial blog Zero Hedge, "three weeks ago, shortly after the Treasury released the latest report on the source and purpose of Treasury issuance, there was little attention on Wall Street, and we confirmed what we first observed a few months ago: as we explained earlier this year, the U.S. Treasury has completely bypassed the Federal Reserve in the past 12 months. 1.5 trillion dollars of liquidity has been injected into the market-not only is it over, but it is about to reverse as the US Treasury releases hundreds of billions of dollars of quantitative tightening.

The reason: after falling to a post-COVID-19 low of $450 billion, the US Treasury's cash balance will first fall to $300 billion and then fall further during the debt ceiling negotiations (although the US has been making an exaggerated gesture for days that the US will not default, the deal will successfully close sometime in the next two months), surging to $800 billion by the end of the year. To be sure, the details of the upcoming quantitative tightening are still changing, depending on the timing of the US debt ceiling. The debt ceiling will be raised or the suspension extended: for whatever purpose, this will happen sometime "in October or November".

However, while there are bound to be some sparks at the last minute, if there is no competitive collapse in the political process, we expect the US to start extending the debt ceiling again sometime in October or early November. To be sure, this means that the modest forecast of $750 billion made by the US Treasury on September 30th will not be met. Instead, the Treasury's cash level will continue to shrink from its current level until some kind of solution emerges.

This raises another question: what is the current cash level of the Treasury? After an increase of $1.8 trillion in July last year, cash in the general account of the Ministry of Finance has fallen to $309 billion, the lowest level since COVID-19 's epidemic. This is largely due to the borrowing ceiling, which prompted the government to reduce paper issuance and cash reserves, while putting huge downward pressure on short-term interest rates, pushing repo rates to negative. And break through the Fed's 0.05% reverse repo "floor", because bills and overnight Treasury reverse repo transactions are lower than the level discussed yesterday.

It also means that the Treasury, which is completely independent of the Fed, has injected $1.5 trillion of liquidity into the market and absorbed a lot of collateral over the past 14 months. that is one reason why reverse repo reached a record $1.2 trillion on Tuesday (and will reach $2,000bn or more by the end of the year). But now there has been a reversal, and although the Ministry of Finance's cash has fallen to the level before the COVID-19 epidemic, it will be higher and rise sharply once the debt ceiling is resolved.

Why are we bringing this up? Because most people ignored this analysis when we released it in May and early August, financial experts began to realize that the Treasury's quantitative tightening will have a far greater impact on market liquidity in the short term than the Jackson Hole meeting.

First, as we've already discussed, at 10:00 EDT on Friday, Powell may or may not announce that the Fed will begin to scale back its bond purchases in September. Just like Goldman Sachs GroupAs pointed out yesterday, "the probability of a formal announcement in November is 45 per cent, the probability of a formal announcement in December is 35 per cent, and the probability of postponing it to 2022 is 20 per cent." The bank also said it expected the Fed to "scale back its bond purchases at a rate of $15 billion per meeting, of which $10 billion is in Treasuries and $5 billion is in mortgage-backed securities." Whether or not Powell announces a reduction in bond purchases, the fact is that even if the Fed starts to scale back its bond purchases in the first quarter of next year, quantitative easing will continue for a long time, as the next Goldman Sachs Group chart shows:

But while the Fed's retrenchment only means that quantitative easing will continue into the middle and late 2022, the Treasury's quantitative tightening will become a bigger factor affecting market liquidity, especially once the debt ceiling problem is resolved. The Treasury began to run out of liquidity at a frenzied rate by issuing bonds, mainly in the form of Treasury bills.

For months, Wall Street has finally realized the real threat to risky assets, as Bloomberg wrote earlier on Wednesday, "Man Group wrote last week, because this means that Treasury Treasury issuance will exceed spending, which is actually a form of quantitative tightening," as we said in early August.

According to Man Group, this "may eventually prompt investors to start cutting interest rate positions, but there is usually a six-week gap between changes in Treasury cash reserves and the impact on longer-term Treasury yields." And because stocks, especially high-duration technology stocks, act as agents for government bonds, once interest rates start to sell, it will quickly spread to FAAMG, which happens to support the entire market right now. This is bound to trigger a crazy sell-off on Wall Street!