GM. This is Milk Road Macro, the newsletter that tracks liquidity like your dad tracks gas prices, obsessively and with a touch of paranoia.
Here’s what we got for you today:
- ✍️ Everything you need to know about the TGA, liquidity and bank reserves
- 🎙️ The Milk Road Macro Show: How Money Supply & Dollar Flight Are Fueling a Bull Market w/ Steve Hanke
- 🍪 OpenAI valued at $500bn after deal
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EVERYTHING YOU NEED TO KNOW ABOUT THE TGA, LIQUIDITY AND BANK RESERVES
A dark cloud hanging over asset markets is about to clear.
The US Government has been draining a lot of liquidity from money markets in recent months.
Half a trillion dollars worth of cash has been sucked out of the economy.
But now this process is nearly over - a positive sign.
And it might also be a signal of a big change ahead at the Federal Reserve.
This is a nerdy (but important) topic - let me attempt to explain it in simple terms.
So, what’s going on?
What are the effects of this liquidity drain?
And what happens next?
Let’s take a look…
So, what’s going on?
Earlier this year, the US Government hit its “debt ceiling”, which meant it temporarily couldn’t issue any “new, additional debt”.
This meant the Treasury was forced to spend down its “savings” - a huge cash pile at the Federal Reserve called the Treasury General Account (TGA).
More than $500bn left the TGA.
When cash is left sitting idle in the TGA, it is effectively “removed from markets”.
But when this money is spent, it can be thought of as a liquidity injection, with cash moving from the TGA and into the economy and markets.
It pushes up a special kind of money called bank reserves - in a similar way to how Quantitative Easing (increasing the Fed’s balance sheet) increases bank reserves.
However, the Government managed to agree on a new debt ceiling deal in June.
Following this, the process of “rebuilding the TGA” began.
Around $500bn has moved in the opposite direction - away from markets and back into the TGA - a liquidity drain.
The TGA target level is $850bn, so this process is now almost over - and will likely be completed in the coming weeks.
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EVERYTHING YOU NEED TO KNOW ABOUT THE TGA, LIQUIDITY AND BANK RESERVES (P2)
What are the effects of this liquidity drain?
Sucking such a huge amount of money out of the economy has knock-on effects.
It causes bank reserves to contract.
Bank reserves are very important for the entire financial system - they’re also known as “base money”.
They are used solely within the banking system (for example, individuals can’t get their hands on bank reserves) - and they basically underpin the ecosystem.
In recent months, the TGA rebuild has caused bank reserves to fall - edging towards multi-year lows.
Now, here’s the thing, if bank reserves fall too low big problems can occur deep in the plumbing of the financial system.
We can monitor if things are becoming “problematic” by looking at a boring, but important, dollar funding market called SOFR (Secured Overnight Financing Rate).
If things are running “smoothly”, the spread between SOFR and IORB should remain below 0.
But in recent times, this spread has been moving higher, which indicates bank reserves may be starting to become “scarce”.
And what happens next?
The Federal Reserve is still conducting Quantitative Tightening (reducing its balance sheet), and has been since 2022 - so it’s still slowly squeezing bank reserves lower over time.
If bank reserves become “too scarce” - we’ve got big problems.
This has happened before, in September 2019, during an event called the Repo Crisis.
Bank reserves dropped so low that the whole financial system temporarily ground to a halt, banks stopped lending to each other, and there was utter chaos.
At that time, the Federal Reserve was forced to abruptly switch from Quantitative Tightening to Quantitative Easing to alleviate the stress and push more liquidity into markets.
(Yes that’s right, many people might not know that the Fed started “light” QE months before the monster QE that occurred when the pandemic struck in early 2020.)
Now, the problem is that nobody really knows at what level bank reserves become “too scarce”.
The general estimate of when bank reserves become “scarce” is between 7% and 10% of GDP.
So, we’re basically edging into that range now.
I think we are currently still quite far from anything like the 2019 Repo Crisis happening again.
But it will still be a mild concern for the Federal Reserve.
This means Fed members may consider stopping the current Quantitative Tightening regime over the coming months.
This would end the downward pressure on bank reserves.
While this QT halt would probably only have a marginal direct impact on financial markets - it would be a big “signal”.
The Quantitative Tightening era would be over - and speculation would then begin to ramp up about when the Fed might start increasing its balance sheet again (Quantitative Easing) and how that process might work.
Wrapping up
The rebuild of the TGA is now nearly over.
This process was a temporary $500bn liquidity drain - and it’s a positive sign for markets that it is coming to an end.
But there’s now potentially issues arising with bank reserves - they may be edging towards becoming “scarce”.
The Fed will be well aware of the need to not let bank reserves fall too low.
So the Quantitative Tightening era could be coming to an end soon.
And the question then becomes - what happens next?
That’s it for this edition - catch you for the next one.
MONEY MOVES THAT MATTER 💸
In today’s episode, we sat down with Steve Hanke to talk about how money supply, dollar flight, and central bank missteps are shaping the next bull market.
Here’s what you’ll hear:
- Why Hanke says money supply, not interest rates, drives inflation and markets
- The danger of ongoing quantitative tightening, even as the Fed cuts rates
- How stablecoins could act as digital dollarization tools
- Why he’s calling for $6,000 gold and sees more bull market upside
Don’t sleep on this one 👇
YouTube | Spotify | Apple Podcasts
BITE-SIZED COOKIES FOR THE ROAD 🍪
OpenAI, the company behind ChatGPT, has completed a deal valuing the company at $500bn. This propels it past Elon Musk’s SpaceX to become the world’s largest start-up.
Parts of the US Government have now officially shut down after lawmakers failed to agree on a new spending bill. This is the first Government shutdown since 2018, and it’s unclear how long it will last.
President Trump said he would confront Chinese President Xi Jinping over Beijing’s refusal to buy American soybeans. This is the latest signal of growing tension between the world’s two largest economies.
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