#54 S2N: What does QT (quantitative tightening) look like?

S2N Spotlight

This is a super important letter, and I will try my best to explain it in simple language. If you follow the pictures, you will understand more than 99% of the people in the financial markets. I update these charts once a week.

The green line and the y-axis on the left show the current size of the Fed’s balance sheet, $7.3 trillion. You can see it peaked at $9 trillion. The orange line and the right y-axis measure the liquidity drawdown. This is a tricky one; it measures the TGA (Treasuries General Account)—essentially Janet Yellen’s current account + RREPO (the reverse repo). You will see in later charts why it is called a liquidity drawdown.

The chart above just shows the orange line in the first chart with its component parts. By the way, you can see that the TGA has grown a lot lately. There are 2 reasons: one is from the proceeds of bond sales. The other is from tax receipts. If I am not mistaken, April is the tax deadline in the US.

Net liquidity is just like it sounds. The Fed’s Balance Sheet less liquidity drawdown (reverse repo + TGA).

Bringing it all together now, I plotted the SP500 (SPY) with the net liquidity of the Fed. I also slipped in a cool little optimisation. The code iterates through different shifts of the liquidity curve to achieve a maximum correlation. In other words, by shifting net liquidity 1 period forward (1 week) there is a 93% correlation with the SP500 following the net liquidity since 2010. As you can see, it has been all the Fed. I have been a slow learner. Don’t fight the Fed. The forecast is for continued drops in net liquidity, which should add pressure on the SP500 to drop as well.