Why is the market rallying during QT? Whence Comes the Liquidity?

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.)

SPX Update: Blue Channel Holds

Last update opined that "INDU and NYA both appear to be incomplete rallies -- so either more upside is needed to complete those patterns, or we're witnessing the early stages of a massive b-wave high with a c-wave (pending)..."

INDU and NYA both made new all-time highs in the wake of that, validating my read that their rallies needed further upside.  SPX retested its high, but has so far held the key blue trend channel, bouncing off it strongly:

SPX at the same time managed to hold its most recent long-term breakout.  If this can continue, then it bodes well for bulls.  A whipsaw does still remain possible as of this moment, though -- this pattern is still "undefined" until it either breaks away or whipsaws:

In conclusion, still not much to add -- but so far, bulls are doing what they need to do.  Trade safe.

SPX Update: Simplifying a Complex Market

Because this is an unusually complex market right now, I'm going to try to simplify things as much as possible for this update, via a series of bullet points:

• Changes from last update: None, except the speculative wxy became immaterial (i.e.- resolution from here will look similar if this is a corrective decline -- whether it's a c-wave or wxy).
• Next support zone to watch: Blue channel; imminent (see first SPX chart).
• Current intermediate/long-term stance: Neutral, pending more concrete signals.
• Current near-term stance:  INDU and NYA both appear to be incomplete rallies -- so either more upside is needed to complete those patterns, or we're witnessing the early stages of a massive b-wave high with a c-wave (pending) that will revisit/break this year's crash low before we see new highs again.  The c-wave is presently presumed to be lower probability, but this is merely a presumption based on odds alone (because the signals at this stage often look identical).

SPX has (not quite, but almost) tested the blue channel.  So far it's holding, but next meaningful support is noted in the event it fails.

Bigger picture, SPX is in the process of testing a major confluence of long-term trend lines.  How this resolves will not be decisive on its own, but will be meaningful information:

In conclusion, I again front-loaded the meaningful data.  Nothing overly bearish has occurred yet, but today could be the first semi-important test for bulls.  Trade safe.

SPX and COMPQ: How the Market Resembles the Weather

Back on August 8, I wrote:

INDU's wave count implies at least one more small wave up still due -- that would be negated if it breaks its most recent low (or if SPX breaks down at blue above).  But as long as those zones hold, then bulls are clear for the uptrend to continue at least a bit longer... though again, we are still in trickier waters here, in the sense that there's a fair amount of overhead resistance, and the possibility for a fifth wave to complete soon.  So until the market breaks out solidly over resistance, it remains ill-advised to get too complacent here. 

And really, for the last month or so I've continued leaning toward more near-term upside, with the caveat that we're still in a larger inflection zone.  Nothing has changed in that regard, but I do want to expand a bit on this.  If you're not experienced with analyzing markets, you may wonder why I can't just proclaim what's going to happen here and be done with it -- but the challenge is that I'm analyzing two very different time frames and getting different signals from them.  The near term pattern has continued to suggest "a bit more upside" (which has happened), but longer-term, we're still within a major inflection zone.

So it's a bit like forecasting the weather:  "Looks like it will be sunny tomorrow, but there is a major hurricane 800 miles off the coast.  As of right now, the cone of uncertainty around the hurricane's projected track is so wide that we're not sure if it will hit us head on -- or miss us entirely.  Best to make preparations just in case."

That's exactly where we are here.  I can't declare an "all clear" yet, because the hurricane is still out there -- but I likewise can't confidently say it's going to hit us yet.  It's there, heading in our general direction, but it may veer off and miss us entirely.  We just can't say one way or the other (although, "won't say" is more accurate; I simply think it's undisciplined at this stage to do so) with high confidence until we see a bit more of the hurricane's track.

So, I've prepared a couple more long-term charts to help illustrate the situation, and an early warning sign.  First up is COMPQ:

Next is SPX, which shows the fresh breakout and the first zones bulls want to hold:

Finally, the SPX near-term chart notes we've reached or are near the next near-term inflection -- though this doesn't guarantee anything, it just offers the market an opportunity:

In conclusion, I'll continue tracking the hurricane's progress, and if it looks like it's veering straight for us, then we'll act accordingly.  Trade safe.

SPX and INDU: INDU Captures Both Its July Targets

INDU finally completed its pattern, thereby bringing honor to its lineage.  Can you believe it was already last month that I wrote about INDU's probable b-wave high?  I can't.  If I didn't know better, I'd swear time was accelerating.

Next up, we talked about a similar option in SPX... and that's probably what this is... but the pattern in ES adds a footnote, making this less of a "slam dunk" than it was for INDU:

Finally, the blue channel is still the first meaningful boundary, and SPX is smack in the middle of it right now:

In conclusion, as noted last week, things are a little trickier as long as the market remains in its larger inflection zone -- hence a reversal, while probably still the underdog, is not so much of an underdog as to bear ignoring it.  Stay nimble until this resolves.  Trade safe.

SPX Update: Near-term Targets

Last updates bullet points were useful, so I'm going to reprint them for anyone who missed it:

1.  We are technically still inside that inflection zone, so we can't entirely rule out a pending reversal.

2.  But if this breakout continues THROUGH that zone, then bulls could trigger another "all clear" for themselves.  

3.  Right now, it looks slightly more likely that bulls will make it through this zone.  Not a given, but I personally wouldn't bet the farm on a reversal yet.

Near-term, SPX appears to have two main options -- up now, or up a short time from now:

Note that the targets on the above chart would be for the current micro wave 3 -- that would then be followed with a small correction in 4, and likely still higher prices in 5.

Nothing's changed on the bigger picture:

Beyond the near-term targets, not much to add from recent updates.  Trade safe.

SPX Update: Keys for Bulls

On August 8, I wrote:  "But as long as those zones hold, then bulls are clear for the uptrend to continue at least a bit longer."  And yesterday, SPX broke out to a new all-time high.  Prior to August 8, I was a bit concerned because the market had entered an inflection zone, and we did get a modest correction out of that zone -- but here's what you need to understand now:

1.  We are technically still inside that inflection zone, so we can't entirely rule out a pending reversal.

2.  But if this breakout continues THROUGH that zone, then bulls could trigger another "all clear" for themselves.  

3.  Right now, it looks slightly more likely that bulls will make it through this zone.  Not a given, but I personally wouldn't bet the farm on a reversal yet.

First up is SPX's blue channel chart -- as long as bulls hold that channel, they have the ball:

Next is SPX's intermediate chart.  Here, we see that as of this moment, SPX is ABOVE the red trend line.  Here again, as long as they hold that breakout, they have the ball:

In conclusion, this is a "fresh" breakout, which means its subject to reversals for a time -- so we can't just assume bulls will run with it and stop watching.  But at the moment, it does look slightly more likely that the breakout may be real, so if bulls can hold this, then they could resume the upward march.  Trade safe.