The Key Driver Behind the US Stocks Rally: Is It Liquidity Instead of Just Interest Rates Topping Out?

Source: FRED, S&P 500

US liquidity proxy line above focuses primarily on the changing size of the Fed's balance sheet, net of other major factors that affect liquidity conditions. These include the Fed's Bank Term Funding Program (an emergency facility which adds liquidity to the banking system), the Treasury general account (which captures how much liquidity is sitting inert in the Federal government's bank accounts), and the reverse-repo window, or RRP (a Fed-controlled facility that sops up unwanted cash from the money markets).

So why has liquidity been rising? Breaking it down further, although the size of the Fed's balance sheet has been decreasing since March, narrowing down to $7.737 trillion as of Dec.6, 2023, the usage of the Fed's Bank Term Funding Program (BTFP) tool has surged by $7.824 billion, marking the largest increase since April 2023. The accumulated size of BTFP was $121.695 billion, setting a record high, which offsetting the narrowing of Fed assets.

Source: FRED

Regarding this issue, we have been reporting on it continuously in our Moomoo News. Read here :

Source: FRED

According to Morgan Stanley's Mike Wilson, the Fed's reverse repo drain is a reserve build, and is turning bullish. More specifically, the draining of the reverse repo facility has continued to help fund the Treasury's elevated amount of issuance over the past 6 months. That issuance has provided the financing for the fiscal deficit which has been a key factor in the stronger than expected GDP growth this year, especially in the third quarter. With over $900B remaining in the reverse repo facility, that balance should continue to be drained toward zero next year and continue to play a supportive role for both Treasury funding and asset prices.

Two aspects of the stock market rally since November are consistent with the liquidity story. First, some of the assets rallying hardest contain echoes of the 2021 bull market, when liquidity was also on the rise. The "Magnificent Seven" that are more sensitive to liquidity have led the market higher, with Nvidia hitting a new all-time high. With the support of large-cap tech stocks, the Nasdaq has outperformed the S&P 500. Second, fund flows are up across the board. Discretionary investors have driven several weeks of fresh inflows into stock, corporate bond, and money-market funds in the US, according to Parag Thatte’s team at Deutsche Bank. Fund flows aren’t everything, but new money entering various asset classes is what investors expect if new cash was pouring into markets.

Source: Financial Times, Morgan Stanley, FRED