Fed's QT Watch: Market Braces for Liquidity Crunch

- Markets are on alert for signs of funding stress that could signal the end of the Fed's quantitative tightening (QT), with a focus on daily repo rates and bank funding volumes.
- A Funding Stress Trigger, based on daily data, has been developed to provide early warning; it previously activated ahead of 2018 and 2019 funding issues.
- With current reserves at $3.6 trillion against an estimated comfortable level of ~$3 trillion, investors should monitor reserve levels and RRP declines for potential market impact.
Monitoring the Fed's QT and Market Liquidity
The Federal Reserve's quantitative tightening (QT) is under scrutiny as markets remain alert to funding and liquidity conditions. A Funding Stress Trigger, based on daily data, has been developed to anticipate potential funding stress. This trigger has activated only twice before, in 2018 and 2019, signaling significant funding rate increases. The current level of reserves is at $3.6 trillion, with Fed member Christopher Waller suggesting a lowest comfortable level of reserves (LCLOR) around $3 trillion. The trigger's criteria include repo rate tails, funding volumes of domestic and foreign banks, and volatility in funding rate spreads. The Fed's standing repo facility and discount window usage are also factors to watch, as they may not prevent funding stress from emerging.
Asset Sensitivity to Fed's Balance Sheet
Asset prices, particularly stocks and bonds, are showing increased sensitivity to the Fed's balance sheet and the reverse repo facility (RRP). As the RRP falls, this sensitivity rises, indicating a vulnerability to falling reserves. The Treasury's strategy of funding borrowing through bills has allowed stocks and bonds to rise despite a large fiscal deficit. The chart provided shows the beta of stocks to reserves plus the domestic RRP, highlighting the growing concern for asset holders regarding the pace of RRP decline and total reserves.
Preparing for Potential Funding Market Disruptions
Investors and traders are advised to remain vigilant to the conditions of funding markets, as abrupt disruptions can have widespread effects on all asset classes. The MacroScope column emphasizes the importance of monitoring the monetary plumbing for early signs of distress, which can be significant for market direction. The standing repo facility and discount window are tools the Fed has introduced to miti $Invesco QQQ Trust(QQQ.US)$ gate funding stress, but their effectiveness before stress becomes apparent is uncertain. The daily price and volume data used in the Funding Stress Trigger aims to capture early indicators of funding distress, serving as a critical tool for market participants. $S&P 500 Index(.SPX.US)$ $Dow Jones Industrial Average(.DJI.US)$ $Nasdaq Composite Index(.IXIC.US)$ $SPDR S&P 500 ETF(SPY.US)$