I saw a take this weekend talking about how "the myth that the market needs QE to rally has been proven false," to which I posted a quick reply about "no, it doesn't need QE specifically, it just needs liquidity -- it doesn't care what the source of that liquidity is." But I figured this was worth expanding upon, so:
Where’s the Liquidity Coming From? (when the Fed says it’s draining)
I've written about liquidity many times, but “liquidity” isn’t one thing. It can be likened to a bunch of pipes that move cash around the system. Stocks don’t care about a single pipe -- they care about net liquidity and how easy/cheap it is to lever, refinance, or buy back shares.
QT (the Fed letting bonds roll off) is a drain. But these "faucets" can offset that drain:
Faucet #1: Treasury spending (deficits)
When the government spends more than it taxes, it’s injecting cash into the private sector. Mechanically: Treasury cuts checks → bank deposits go up → bank reserves go up. That’s fresh liquidity, regardless of QT.
If Treasury is drawing down its "checking account at the Fed" (the Treasury General Account, or TGA), that’s an extra push of cash into the system. If Treasury is rebuilding the TGA, that temporarily soaks up cash. Either way, big deficits are a steady source of flow to households, firms, and markets.
i.e.- Persistent deficits = ongoing liquidity drip, even while the Fed is trimming its balance sheet.
Faucet #2: ON RRP draining
Money market funds had parked a mountain of cash at the Fed’s overnight reverse repo (RRP) facility (~$22–48B last week, down from >$2T at the peak). As front-end yields and Treasury bill supply shifted, funds moved cash out of RRP into bills and repos.
Less cash at RRP means more cash circulating in private markets. It’s not “QE,” but it re-routes idle cash back into funding markets where it can support trading, lending, and risk.
i.e.- The collapse in RRP balances has been a powerful, under-appreciated offset to QT.
Faucet #3: Treasury’s mix (Bills vs. Bonds)
When Treasury leans on T-bills, money market funds can buy them quickly with minimal market strain, and dealers’ balance sheets turn over faster. That keeps front-end funding loose.
Heavy coupon issuance, by contrast, soaks up duration and can tighten financial conditions more. The quarterly refunding mix matters.
i.e.- A bill-heavy issuance strategy keeps the plumbing flowing.
Faucet #4: Bank and shadow-bank credit
Banks don’t need to expand their balance sheets for “liquidity” to show up in markets -- private credit and the repo complex can do a lot of lifting. If funding is available and spreads are calm, leverage creeps back in: basis trades, dealer intermediation, PE financing, margin availability, etc.
i.e.- The non-bank system pushes liquidity where it’s rewarded, often faster than policymakers expect.
Faucet #5: Corporate cash & buybacks
U.S. corporates are cash-rich. They issue debt when it’s cheap, hold cash when it’s not, and buy back stock when risk appetite is high. Buybacks are a direct demand source for equities -- one that can overpower a lot of macro hand-wringing in the short run.
i.e.- Corporate treasurers are their own liquidity engine.
Faucet #6: Interest payments are (weirdly) stimulus
Higher rates mean the government pays more interest to bondholders. That’s income to the private sector. It doesn’t feel like “stimulus,” but it is a cash flow transfer that supports spending and portfolios.
i.e- Rate hikes shrink some liquidity (QT, pricier credit) but add income elsewhere.
So how can markets rally during QT?
Because "total net plumbing" > one drain (Quantitative Tightening; QT). If deficits + RRP runoff + bill-heavy issuance + private credit + buybacks are collectively looser than the QT drain is tight, the water level can rise or stay high. Add in easing financial conditions (narrower credit spreads, improving earnings, or even modest rate cuts) and multiples expand.
A simpler metaphor: the Fed has one foot on the brake (QT), while fiscal and market plumbing sometimes have a heavier foot on the gas.
What to watch:
1. TGA trend: Falling TGA = cash going into markets; rising TGA = cash out (temporarily).
2. ON RRP balance: Lower = more cash re-entering private pipes.
3. Treasury issuance mix: More bills tends to be looser than heavy coupons. Treasury maintained coupon sizes for ‘the next several quarters’ and telegraphed further bill increases into October.
4. Bank reserves & repo spreads: If SOFR persistently prints above IORB (or GC repo blows out vs ON RRP), you’re flirting with reserve scarcity. If it’s calm, the plumbing’s fine (at least, as far as it knows).
5. Buybacks & equity supply: High authorizations/shrink = steady bid.
6. Credit spreads: Tight spreads = easy funding = more “liquidity-like” behavior.
So the bottom line is, QT matters, but it’s just one variable in a multivariate system. Right now, the reason markets can rally “into QT” is that other faucets have been open -- notably fiscal flows, RRP drainage, issuance choices, private credit, and corporate actions. Until the drains outrun the faucets, liquidity (and risk appetite) can hold up.
The net result is: the water level doesn’t fall as fast as people expect, and may even rise. Despite QT draining, deficits plus bill-heavy issuance plus cash leaving ON RRP mean plenty of money is still sloshing around where it can fund trades, repo, buybacks, etc. -- which is why risk assets can rally.
Liquidity Right Now:
TGA (Treasury’s checking acct): ~$526B (Aug 20). Treasury also targets ~$850B by end-Sep per its borrowing update. More cash in TGA = temporarily less cash in markets while they rebuild it.
ON RRP usage (MMFs at the Fed): ~$36.3B (Aug 22) -- near cycle lows. Cash has migrated out of the Fed’s facility into bills/repo, which adds liquidity back to private markets.
Bills vs. bonds (issuance mix): bill faucet is open. Treasury says it will lean on bills through Sep and lift bill sizes again in Oct. Their own math implies +~$537B to bills this quarter and +~$143B next quarter if coupons stay steady. That’s a big offset to QT.
Bank reserves (cash at the Fed): ~$3.30T (Aug 20) -- still ample by historical standards. Reserves are the shock-absorber that keeps funding calm even while QT runs.
Fed balance sheet: ~$6.62T (Aug 20) -- down a lot from the $8.9T peak, but not “tight” enough to choke flows given the faucets above.
So... that's it in a nutshell. QE and QT aren't the only sources, or drains, of liquidity. One can't compare them as if they exist in a vacuum and declare the game over, one must take the full picture into account.
(Note: Today's update will be published separately, below this.)
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